The 5 C's method for evaluating a credit application
FINANCE
It's no secret that banks verify your financial solvency before approving a loan, whether personal or business.
Although each bank may have different requirements, most are guided by certain common principles, known as the 5 C's of Credit.
The 5 C's of Credit are: Capital, Character, Collateral, Conditions, and Capacity.
The 5 C's method The 5 C's method for evaluating a credit application
The 5 C's of Credit are: Capital, Character, Collateral, Conditions and Capacity.
It's no secret that banks check your financial solvency before approving a loan, whether personal or business.
Although each may have different requirements, most are guided by certain common principles, known as the 5 C's of Credit.
Why are the 5 C's important for an entrepreneur?
Financing can help business owners with a variety of situations, from emergency expenses to asset purchases. Understanding the 5 C's of Credit can increase the likelihood of obtaining the funds their business needs at a lower rate, with a longer term and more favorable terms.
Each lender assigns a different weight to the 5 C's, so it's important to identify the areas your business needs improvement and the lender's specific requirements so you can achieve your financial goals.
1.- Character
Your business character refers to the lender's overall impression of your credit. Lenders consider payment history on previous debts and length of time in business to determine whether an owner can be trusted to handle a new loan.
Specifically, a bank will evaluate the following:
• How long have you been in business?
• What is your history of paying debts on time?
• What is the business's history of paying its debts on time?
• What experience does the owner have in that industry?
How can you improve?
• Use a business credit card responsibly to establish a positive credit history.
• Make your outstanding payments on time, both personal and business.
• Build a relationship with a lender using a business checking account or other financial products.
2.- Capacity
Capacity refers to the business's ability to repay the loan. Lenders will be more inclined to approve a loan if they are confident that your company has sufficient cash flow to support additional debt. A bank may consider, in addition to the business's current performance, future financial projections.
For example, a lender might consider cash flow statements, the number of active customers and/or contracts the business has, the debt-to-income ratio, and past and present payment arrears.
The business may be disqualified if it has a history of late payments, deficiencies in payments, or bankruptcy.
How can you improve?
• Try to improve cash flow and increase revenue
• Build business credit by paying on time
• Pay off your debts before applying for new credit
• Have reports on hand that show the company's revenue and its potential, based on new products or new contracts.
3.- Capital
Capital refers to the amount of financial investment the owner has made from his or her own resources. As a general rule, lenders will view applicants who have made a larger investment more favorably before applying for outside funding. This typically means the owner is seriously investing in the business's success.
Although banks rarely disclose the minimum capital they require, they usually look favorably on owners who have invested personal savings in the business.
How to improve
• Use personal funds and explore other options before applying for a loan
• Be prepared to offer collateral instead of funds
• Keep a record of any assets, such as equipment, that you have acquired with personal funds
4.-Collateral
Some lenders require you to provide hard assets or working capital to secure a business loan. This is known as collateral. This collateral can be seized if you default on the loan, which helps reduce the lender's risk.
If you can't offer collateral, the lender will likely require a personal guarantee to secure the loan.
How can you improve?
• Make a list of possible collateral, keeping in mind that you can use both available physical assets and future earnings.
• Offers to place a personal guarantee
5.-Conditions
Banks traditionally consider general economic conditions, as well as the conditions of the specific industry where the business operates, when evaluating a loan.
If your business operates in a high-risk industry, the loan amount will likely be lower than if it operated in a more stable and predictable sector.
Likewise, banks will take into account the specific trends of your business.
How can you improve?
• Consider requesting credit increases when your business is in a stronger position
• Do not request more funds than you need
• If you can, wait for the economy to enter a positive cycle before applying
Summary
Keeping the 5 C's in mind can generally increase your chances of getting a loan. If you can't get funding from a traditional bank, there are other alternatives that may have less stringent requirements and faster procedures.
There are also certain measures you can take to improve your chances of accessing credit, reducing the risk for the lender.