The Five Cs of Credit Analysis
Whether you’re seeking funding through a Small Business Administration loan guarantee, a bank, or a local development corporation, prospective lenders will work hard to try and determine your creditworthiness. A thoroughly documented loan request, including a comprehensive business plan, will help them better understand you and your business.
Virtually all lenders rely on some variation of the “five Cs” of credit analysis to determine whether they’ll fund your business. These are: capacity (your ability to pay back a loan), capital (your net worth), collateral (assets to secure the debt), conditions (of the borrower and the economy at large), and character (of you, the borrower).
Understanding the Five Cs
- Capacity: Prospective lenders will want to know exactly how you intend to repay a loan. They’ll consider the cash flow of your business, your proposed schedule of repayment, and the probability that you will, in fact, successfully repay the loan. Your payment history on existing credit relationships, personal or commercial, is considered an indicator of your future payment performance. Prospective lenders will also want to know about your “backup” sources of repayment.
- Capital: This is the money you have personally invested in your business -- and subsequently stand to lose -- should your business fail. Prospective lenders like to see that you’ve used some of your own assets and taken on personal financial risk to establish your business before you ask them to give you any of their money. They also want to know how much debt your company can handle. There are numerous financial benchmarks, including debt and liquidity ratios, that lenders use before advancing funds to anyone.
- Collateral: This is security you can provide the lender. You pledge an asset, such as your home, to the lender with the agreement that the lender can take it if you can’t repay the loan. This is different from a guarantee, where someone else signs a document promising to repay your loan if you can’t. Some lenders may require both.
- Conditions: What do you intend to use your loan for? Are you seeking money for working capital, additional equipment, or inventory? Lenders want to know this. They’ll also consider the economic climate in your industry -- and other industries -- all of which affect the success of your business. If your business is sensitive to economic downturns, a lender will want reassurance that you’re adept at managing productivity and expenses.
- Character: Prospective lenders will want to know that you’re trustworthy enough to repay your loan. They can never be 100 percent certain, of course, but they can and will review your educational background and your experience in your industry. The quality of your references is also critical. Lenders want to put their money with clients who have the best credentials and references.
Finally, it’s a good idea to review your credit profiles regularly. Contact one of the credit bureaus to obtain your business credit report and check for any errors or omissions. This information will be shared with lenders.
Susan Konig is a freelance writer in New York. She has been writing about finance for 15 years, for publications including Crain's New York Business, The New York Times, and Registered Representative, a national publication for financial advisors.
