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CA Intermediate · Financial Management and Strategic Management · Management of Receivables

Which of the following best describes the 'Five Cs of credit' used in assessing a customer's creditworthiness, and the meaning of 'Capacity' within it?

Capacity in the Five Cs of credit means the customer's ability to repay its obligations from operating cash flows. Security offered is Collateral, willingness to pay is Character, and economic environment is Conditions, so only the cash-flow meaning fits Capacity.

  1. ACapacity refers to the customer's ability to repay from its operating cash flowsCorrect
  2. BCapacity refers to the assets pledged by the customer as security against the credit
  3. CCapacity refers to the customer's reputation and willingness to honour obligations
  4. DCapacity refers to the general economic conditions affecting the customer's industry

Explanation

In the Five Cs, Capacity is the ability to pay out of operating cash flows and liquidity. Collateral is the pledged security, Character is willingness to pay, and Conditions are the economic environment. Options 2, 3 and 4 therefore describe other Cs.

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