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Credit evaluation involves determination of the type of customers who are going to qualify for the trade credit. Several costs are associated with extending credit to less credit-worthy customers. When more time is spent in investigating the less credit-worthy  customers, the cost of credit investigation increases. As the credit rating of the customer decreases , the chance that the amount will not be paid increases. Collection costs also increases as the quality of the customer declines. In a nutshell, the decline in customer quality  results increased cost of default, collection and credit investigation.

Assessment of the credit worthiness of a customer is subjective matter & lot depends upon the experience and judgment of the person taking the decisions.

There are three basic factors of credit worthiness of a customer.
a)The character i.e., willingness and practice of the customer to honor his obligations by paying  as agreed.
b)The capacity i.e., the financial ability of the customer to pay as agreed.
c)The collateral i.e., the security offered the customer against the credit.

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