The Five C’s of Credit

Often, borrowers are overwhelmed with the information they need to provide. Thankfully, the Five C’s of Credit are a good way to sort out the preparation for the lending process.

Familiarize Yourself with The Five C’s:The concept of the Five C’s of Credit is based on the long-standing reliance of creditors on their ability to successfully examine the risk involved in lending money to small businesses.

• Collateral: Some form of liquid asset that could – in times of trouble – be instantly converted into cash in order to repay a loan. A loan is usually a percentage of this liquid asset. For example, a lender would finance 80% of a company’s accounts receivable. So any asset of value that the company owns (free and clear) can be borrowed against.
• Capital: The more capital the owners of the company have invested in their own company, the greater their equity stake in the business. A lender likes to know a borrower will not simply walk away from the company. Lenders want to see that the owners have a lot to lose and therefore be careful with their decision-making. This has the effect of lowering the risk.
• Character: All types of capital providers want to see who is going to execute the plan. What sort of history does the team have in their industry? Have they been successful in the past bringing their ideas to fruition? Does their personal credit history show bad management of cash with tax liens and judgments? Unfortunately, individuals who show the willingness to walk away from obligations have a tougher time getting a loan.
• Capacity: The business model figures largely in the ability to repay a loan. With a term loan, the lender will determine within specified ratios if the business can maintain profitability while adding a new expense – the loan payment. With invoice factoring this does not apply, since each funding event is based on an individual invoice that will be repaid by an account debtor. But generally speaking, how the loan will be repaid is critical to the decision to lend.
• Conditions: What is the intended use of the requested funds? Knowing how much you are looking to borrow and what you need the capital for are important. The lender needs to see that you are competent enough to answer these questions. In your business plan, show how you can overcome any potential obstacles. On a broader scale a lender might look to whether your particular industry, or agency that you are working with, are on the upswing or possibly winding down.

Credit is based on history and future potential. The earlier you control your credit history, the better the chances are of breezing through the loan process. By keeping the Five C’s in mind when you’re making the decision to grow, you will ultimately help increase your access to the lifeblood of any business – working capital.