The Five C’s of Lending Decisions

Character: What kind of borrower will you be for the bank? The best clue to your character is your personal credit history. Most banks will check how well you have managed your personal debt in the past. What if you do not have personal credit history? Personal references, business experience and work history can sometimes substitute, but a strong personal credit history proves that you have the willingness and the discipline to repay past debts — and future obligations.

Credit: Many banks use a business credit-reporting agency to see how you have paid your trade suppliers and other business obligations. They use a consumer credit-reporting agency to see how you have handled your personal debt, (Equifax, TransUnion, and Experian).

Cash Flow: Most banks are cash flow lenders. That means they look at the cash flow of your business as the primary source of repayment for the money they lend. How does a bank compute cash flow? A company's cash flow is its net profit, plus its non-cash expenses, (depreciation and amortization). A typical rule of thumb is that for every $1 in total loan payments, your business must generate $1.50 in cash flow.

Capacity: Most lenders will want to know your ability to repay your loan in case there was a sudden downturn in your business. Do you have the capacity to convert other assets to cash, by either selling them or borrowing against them? Your ability to do this could include real estate holdings, certificates of deposit, stocks and other sources of savings that can be liquidated quickly.

Collateral: Banks make both secured and unsecured loans. With a secured loan, you pledge something that you own as collateral. It might be personal assets like certificates of deposits or stocks, or business assets like real estate, inventory, equipment or accounts receivable.

Here are some important questions to consider before you apply for credit.

1. Are you the principal decision-maker for your business?

If you are, you will be asked to complete and submit the loan application. If there are multiple owners of your business, then typically at least two of them will need to submit their information with the application.

1. Have you been in business at least five years and profitable for the past three years?

Your financial performance over time is usually a good measure of where you have been and where you are going. To get conventional bank financing, it helps to have been in business for at least five years and profitable for the last three years.

1. Have you filed for bankruptcy within the past 10 years?

If either you or your business has declared bankruptcy within the last 10 years, chances are most banks will not lend to you — unless you have repaid all of your creditors. The best way for you to re-establish a good credit record is to repay your creditors as soon as possible.

1. Have you consistently paid your bills — both business and personal — on time?

Many banks use a business credit-reporting agency to see how you have paid your trade suppliers and other business obligations. They use a consumer credit-reporting agency to see how you have handled your personal debt. While an occasional late or missed payment is understandable, if you consistently pay late, you may not qualify for business credit. Sometimes you just need to set up an accounting system to ensure that you pay all your bills on schedule. If you find that you are consistently running short of cash, then you should take steps to trim expenses, increase sales revenues or raise equity for your business.

1. Is there a tax lien, suit or judgment against you or your business?

In the case of a tax lien or a legal judgment against you or your firm, the beneficiary of any settlement stands first in line for payment. The best thing to do before you apply for business credit is to pay and release all liens and judgments, and settle all suits.

1. Do you have five or more sources of credit?

Credit cards, lines of credit and loans are a key part of every individual's credit record. A strong credit history proves you have the willingness and discipline to repay debts. Lack of a credit record makes it much more difficult to borrow money. If you do not have credit today, secure credit soon and use it wisely. Good places to start include trade credit, credit cards, auto loans, home equity and lines of credit.

1. Has your business been profitable for the last three years?

Tax returns are a quick way to determine if you have shown a profit in the last few years. If your business is not profitable, it may be difficult for you to make the payments on your credit line or loan. So, if your business is not profitable, examine your expenses for opportunities to cut back and look at your sales for opportunities to increase revenues. Maybe you can sell more to a current customer. Alternatively, you might need more customers. You can also visit http://www.sba.gov/ for details on the U.S. Small Business Administration and information on government programs for small business owners.

1. Does your business generate at least $1.50 in cash flow for every $1 you pay out to cover expenses?

Many banks look at the cash your business generates as the primary repayment source for the money they lend you. Banks compute the cash in your business by adding non-cash expenses (such as depreciation and amortization) to net profits. If your business does not generate $1.50 in cash for every $1 in debt payments, then you will need to look for ways to decrease expenses or increase sales to boost the cash in your business. 

Are you ready to apply for business financing, or do you have questions? Call or email us we are here to help you and your business!