Small Business Development Center
At Chemeketa Center for Business & Industry
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The 5 C’s of Credit

By Chemeketa SBDC

Businesses require capital to start, run and grow. Where does it come from? Isn’t that a large piece of the successful business puzzle? Many small businesses must save for years or invest inheritance or retirement funds, while others borrow from friends and family.

While these are successful venues to pursue in raising funds for business, they are not always available. Who is always available? The bank.

Visiting a bank is not a guarantee that you will receive needed funds; typically, about one in four businesses will be successful in getting a loan. Why is that number so low? Banks want to lend in a manner that brings the greatest return for the least risk. In other words, they want to know they’ll get their money back.

So your job as a potential borrower is to demonstrate that you are capable of repaying what was borrowed and that you are a minimal risk to the bank. Banks look at potential borrowers and assess their 5 C’s: character, credit score, capacity, capital and collateral. Bankers often use this term to describe the considerations given to the borrowing ability of a small business.

A bank is going to assess your character. This is often picked up during the interview process and throughout your work with the loan officers. Do you have a history of paying on time? How do you treat your managers, employees, vendors and customers? This is a subjective judgment but is one of the 5 C’s, a piece of the decision-making process.

On the flip side, the next test is not so subjective. Credit score is often a make-or-break consideration. A credit score demonstrates your commitment to meeting your financial obligations. There is not a concrete minimum score; each institution sets its own policy regarding credit scores. Having a high score increases your chances of borrowing money.

Free reports are available, and you should review your score at least annually. This will help you identify ways to clean up your credit. It also provides a basis for comparing yourself to other borrowers, as most reports tell you where you rank nationwide. You can work on your credit score for months and even years in advance of applying for a loan to position yourself to be lendable.

Capacity is where your projections are used. What is your ability to repay the loan? A banker will look for sufficient cash flows to cover your debt repayments, not just to this bank but to all the sources from which you have borrowed funds.

Debt-to-income ratios are used in making these determinations. Most homebuyers are familiar with this computation. When looking at your total debt payments as a percentage of your total income, it must be below certain thresholds determined by the bank to keep its risks at moderate levels.

Next comes the skin-in-the-game test. A lender wants you to invest, not just your time and efforts, but your money into the business as well. Capital. This is often a deal breaker as many people expect to be 100 percent financed. Typically you will need to contribute 20 to 30 percent of the capital. These funds are often raised from friends, family or retirement withdrawals.

The last of the 5 C’s is collateral. Your lender wants to know how it can get its money back if you default and don’t repay. If you pledge real estate or capital equipment as collateral, then you can be forced to sell the assets and the proceeds used to repay your creditor. Remember, banks are risk averse, and having sufficient collateral allows them the best opportunity to recover their funds, but such a drastic measure is typically a worst-case scenario.

Banks are great to work with. They want to lend money. But will they lend to you? Are you bankable? That is for the bank to determine, but if you strive to improve your 5 C’s, you are giving yourself the best chance at raising the funds necessary to start, run and grow your small business.

 

About Chemeketa SBDC

We provide the tools and environment for small business owners to make great decisions.

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