Banks consider more than a company‘s credit report when a business owner applies for a loan. Banks take into account several factors – known throughout the banking industry as the “5 Cs of Credit”: Capacity, Capital, Collateral, Character and Conditions. These serve as the basis of a bank’s credit analysis when considering a loan request. Examining the “5 Cs” more closely provides additional insights and expectations:
Capacity is the ability to generate enough cash flow to repay the loan.
Capital denotes the financial strength of the company. The bank is looking for the owner to have sufficient equity in the business – important to the bank for two reasons. First, sufficient equity provides a cushion against a potential financial setback. Second, the bank is looking for the owner to have sufficient “skin in the game,” which means if something goes wrong, the owner would be motivated to stick by the business and work with the bank during a turnaround.
Collateral is what the borrower uses to secure the loan. Typically, the bank wants the value of the company’s collateral to exceed the loan amount; the collateral is a tertiary source of repayment of the loan. If the company or the guarantor is unable to generate sufficient cash flow to repay the loan at some point in the future, the bank wants to be able to liquidate the collateral and using the proceeds to pay off the loan.
Character refers to the financial history and integrity of the borrower. The bank wants to lend to a business owner who has kept his or her nose clean, paid their bills on time and has a strong credit history. Character also speaks to the experience of the principals.
Conditions cover the various micro and macro economic factors affecting the business: local market conditions, strength or weakness of the industry category, and overall economic conditions.
Although there is more to determining the credit-worthiness of a borrower, the “5 Cs” represent the basic questions a borrower should be prepared to answer when applying for a business loan.
Investors Bank offers loans to business of all sizes. If you would like more info on the application process, a good place to start is at your local branch.