The 5 C's of Credit: What They Mean to Your Business

Businesses face any number of financial challenges. Often, it's as simple as needing financing to grow and stay competitive, expand business operations, purchase assets such as new equipment or a commercial building, or even consolidate and restructure business debts.
One of the most common questions among small business owners seeking financing: "What will the bank be looking for from me and my business?"

While each lending situation is unique, many lenders utilize some variation of evaluating the five Cs of credit when making credit decisions: 

 1. Character:

• What is the character of the management of the company?
• What is management's reputation in the industry and the community?

Investors want to put their money with those who have impeccable credentials and references. The way you treat your employees and customers, the way you take responsibility, your timeliness in fulfilling your obligations — these are all part of the character question.

This is really about “you” and your personal leadership. How you lead yourself and conduct both your business and personal life gives the lender a clue about how you are likely to handle leadership as a CEO. Your character immediately comes into play if there is a business crisis, for example.

As small business owners, you place your personal stamp on everything that affects your company. Often, banks do not even differentiate between “you” and “your businesses." This is one of the reasons why the credit scoring process evolved, with a large component being your personal credit history.

2. Capacity:

• What is your company's borrowing history and track record of repayment?
• How much debt can your company handle?
• Will you be able to honor the obligation and repay the debt?

There are numerous financial benchmarks, such as debt and liquidity ratios, that lenders evaluate before advancing funds. You should become familiar with the expected pattern in your industry. Some industries can take a higher debt load; others may operate with less liquidity.

3. Capital:

• How well capitalized is your company?
• How much money have you invested in the business?

Lenders often want to see that you have a financial commitment and that you have put yourself at risk in the company. 

Both your company's financial statements and your personal credit are keys to the capital question.  If the company is operating with a negative net worth, for example, will you be prepared to add more of your own money? How far will your personal resources support both you and the business as it is growing?

If the company has not yet made profits, this may be offset by an excellent customer list and payment history. All of these issues intertwine, and you want to ensure that the lender perceives the business as solid.

4. Conditions:

• What are the current economic conditions and how does your company fit in?
• What are the trends for your industry, and how does your company fit within them?
• Are there any economic or political “hot potatoes” that could negatively impact the growth of your business?

If your business is sensitive to economic downturns, for example, the bank wants a comfort level that you're managing productivity and expenses.
 

5. Collateral:

·         Primary Source of Repayment

·         Secondary Source of Repayment

Business cash flow will nearly always be the primary source of repayment of a loan. Lenders also look at what they call the secondary source of repayment such as business assets and the strength and financial support of guarantors.

Collateral represents assets that the company pledges as an alternate repayment source for the loan. Most collateral is in the form of hard assets, such as real estate, business assets or equipment. Alternatively, your accounts receivable and inventory can be pledged as collateral. The collateral issue is a bigger challenge for service businesses, as they have fewer hard assets to pledge.

Until your business is proven, you're nearly always going to pledge collateral. If it doesn't come from your business, the bank will look to your personal assets.

Keep in mind that when evaluating the 5 Cs of credit, lenders do not place equal weight to each area. Lenders are cautious, and one weak area could offset all the other strengths you show.

Debra Murphy is Vice President and Relationship Manager at Union Bank. She works with small to medium sized business in the Inland Empire and tailors financial products and services to help businesses grow, expand, and get to the next level.

Accessing Capital in a Tight Credit Market

Many business owners and prospective business owners are discussing how difficult it is to access capital in this market. The fact is the credit market is tighter than it has been in a number of years. Banks are concerned about regulators; therefore, they are requiring more documentation and standards are tightening. However, accessing capital for growth and expansion, for commercial real estate purchases and for business acquisitions is achievable. Consider the following to position your business for accessing capital:

• Know Your Financial Health – Know what’s coming into your business (revenue) versus what you are spending (expenses). No longer can that responsibility be solely delegated to a bookkeeper. Business owners must be clear on their company’s financial health and projections for the future. A healthy balance sheet and income statement that shows positive trends or clear adjustments for sales shortfalls is essential. In this market, don’t hesitate to make adjustments that will improve your bottom line. Waiting too long could negatively impact efforts to access capital.
• Be Attentive to Accounts Receivables (A/R) – Business owners often obtain credit from suppliers and provide credit to customers. Today, CEOs must be attentive to the accounts receivable cycle of their customers. When A/R has not been received in 15 days in a 30-day cycle, a call should be made to the customer. Reducing the A/R cycle improves a business’s cash flow, which is essential in accessing capital.
• Explore SBA Resources – The U.S. Small Business Administration (SBA) has several programs to assist small businesses in working with banks. SBA provides a guaranty program and a direct lending program. The guaranty program provides a 75-85 percent guarantee to banks for providing capital to small businesses and the direct lending program funds up to 40 percent of project costs for real estate, equipment or tenant and leasehold improvements. In this market, this proves to be a valuable resource to lessen the credit risk to banks.
• Take Advantage of the Market – Commercial and industrial real estate prices are down 25 – 30 percent. If you currently rent space, now is the time to explore being an “owner” versus a “renter.” Real estate owners are able to reduce their tax liability and could create additional income with rental space. The SBA 504 loan program allows owners to rent up to 49 percent of their real estate; requires only 10 percent down versus 30-40 percent conventionally, provides low and fixed interest rates; and provides longer terms so that monthly payments are manageable.

Business owners can access capital in today’s economy and there are numerous resources available to help. To find out more information about SBA programs and other resources for small businesses, contact AmPac Tri State CDC, a non-profit certified SBA lender at (909) 915-1706 or visit our website at http://www.tristatecdc.com/.