Q: Why are operating deposits classified as a liability account?
A: Operating deposits are cash amounts provided to Total Coverage as down-payments, in effect on work to be perfomed by Total Coverage. Therefore, Total Coverage recognizes these deposits as obligations, or liabilities, that it must satisfy by providing the services it has promised the client. Think of them, too, as advanced cash payments for a product to be delivered later. Total Coverage is obligated to deliver the product and, therefore, reports this obligation in the liabilities section of its balance sheet according to GAAP.
Q: What is the order of importance for the Five Cs?
A: This varies by institution due to credit culture differences. However, some variation of this order is most likely to prevail in all institutions.
- Character: Character permeates every aspect of the business, and without Character there is no reason to move forward with a transaction, so that is generally regarded as #1 in order of importance.
- Capacity: Capacity measures the primary source of repayment for the credit. If capacity is a weakness, it is difficult to mitigate.
- Conditions: Even the best leadership and management can fail in adverse conditions. The business must have the ability to compete and be successful in the market in the conditions that exist.
- Capital: Capital is an evaluation of the secondary sources of repayment, which can mitigate certain weaknesses in the first three Cs noted above.
Last in order of importance is Collateral. No amount of Collateral will make up for a credit that lacks a primary and secondary source of repayment or for management that lacks Character. Collateral is the tertiary source of repayment, the last way out of a credit; hence, the reason we think it is last in order of importance for the five Cs. Collateral is valuable in mitigating weaknesses and potentially minimizing losses in the event of default, but it is not the driver in a credit decision.