Definition
The term ability to pay refers to the capacity of a borrower to successfully make the interest and principal payments on its debts. A borrower's ability to pay is one of the critical factors lenders evaluate before writing a loan.
Explanation
Also known as financial capacity, a borrower's ability to pay is the most important factor a lender should evaluate before loaning money. While a borrower's ability to pay can involve a large set of analytical tests; the capacity to service debt is largely a function of the borrower's ability to generate cash. It is also a function of the borrower's assets that can be readily converted into cash.
One measure that quantifies a borrower's ability to pay is its credit rating. Firms such as Fitch Ratings, Moody's, and Standard & Poor's specialize in analyzing a borrower's financial statements and assigning a letter grade to the company's outstanding debt. While all three firms have slightly different rating systems, AAA generally indicates the highest credit quality (investment grade), while D is considered speculative (junk) quality. Since the likelihood of default is directly related to credit quality, those borrowers with lower ratings will pay the investor-lender a premium, in terms of interest rates than those with higher credit ratings.
Related Terms
.png)
The financial accounting term liability is used to describe the debt of a corporation that results from a transaction involving the transfer of an asset or the provision of a service. Liabilities are reported on a company's balance sheet.
Moneyzine EditorNovember 6th, 2024- Moneyzine EditorNovember 6th, 2024
The financial accounting term interest expense is used to describe the interest payments that have come due on amounts borrowed by a company or an individual. Interest expense will appear as a line item on a company's income statement.Moneyzine EditorNovember 6th, 2024
The financial accounting term deep discount bonds refers to indentures that are sold at a price significantly lower than face value, typically 20% or more. Deep discount bonds can also include zero coupon bonds, which do not pay a rate of interest to the holder.Moneyzine EditorJanuary 15th, 2024.png)
The financial accounting term income bond refers to a debt security that provides for periodic coupon payments if the company has sufficient earnings. Interest payments to holders of these securities are not guaranteed. Income bonds are typically issued by companies that are struggling financially.Moneyzine EditorNovember 6th, 2024
The term general obligation bond is used to describe a debt security issued by state or local governments. Unlike a revenue bond, which is secured by a specific income-generating entity, a general obligation bond is secured by the municipality's pledge to use all legally available means, specifically tax revenues, to repay this debt.Moneyzine EditorNovember 6th, 2024
.png)
.png)
.jpg)
