The competition to get SMB loans is growing every day, and banks have enacted stricter loan regulations. When you apply, a bank will undertake a risk assessment to decide if you will receive the loan and under what conditions. Make sure you understand the 5 C’s when you fill out your loan application. It’s what the bankers are looking for, and it will strengthen your chances of receiving a business loan.
Capacity: Your ability to repay
In the opinion of the bank, capacity may be the most important of the 5 C’s. The bank wants to make sure the business will generate enough cash from daily operations to cover loan payments. The best way for the bank to determine capacity is by analyzing the historical cash flow generated by the business.
“Capacity also refers to your credit history,” says Rosemary Peavler, college professor of Business Finance. “Do you have a good credit score? The bank will look at your past repayment history, both business and personal. Don’t forget to indicate every possible source of repayment at your disposal in your application.”
Collateral: Something you put up in case you don’t repay
To reduce the risk of lending, banks want to know you have assets that can act as another method of repayment. Collateral could include equipment, real estate, inventory, account receivables, and securities. Obtaining small business credit and providing guarantees may seem troubling, but banks really do not want to exercise their position on seizing and liquidating assets. In most cases, a banker will work to find payment solutions.
“Collateral may also include a guarantee by someone else that, in case you cannot repay the loan, the other party will,” says Peavler. “As money gets tight in the economy, there is an increased chance that banks will require loan guarantees in addition to collateral. You may know loan guarantees by the term ‘co-signer.'”
Conditions: What’s going on in the marketplace
This is a review of what you plan to do with the loan. The bank wants the money to be used for a meaningful business purpose. Is it revenue for expansion, inventory, or buying equipment? Condition also applies to the external environment that can impact a company’s ability for repayment, such as customer base, competitors, liabilities, and economics.
“During a recession or periods of tight credit, it is obviously more difficult for a small business to repay a loan and more difficult for a bank to find the funds to loan,” says Peavler. “It becomes even more important for the small business firm to present an iron-clad loan application to the bank.”
Capital: Your ability to raise funds or have backers
A business owner’s investment into their own company sends a message of confidence and the ability to repay the small business credit or loan. Net-worth and equity are the two key financials used. Ultimately, if a business owner is unwilling to invest his or her own funds in the company, then banks are also unwilling to take the risk.
“Before applying for a bank loan, the owner has to have a significant investment in the business before a lender will even consider making a business loan,” says Peavler.
Character: Your trustworthiness
The last C doesn’t always get the attention it should, but it’s absolutely essential. The bank assesses the trustworthiness of the business owner. Factors for character criteria are: business experience and knowledge, personal and/or small business credit history, references, and education.
“This is where the education and experience of the client comes into the picture,” says Peavler. “Your references and background in your industry are considered by the financial loan officer.”
Talk to an accountant
The 5 C’s cover the essentials of a small business loan. Bank loans can get complicated. It’s crucial to educate yourself, but you should also consult an accountant before applying for any sizeable loan. He or she can help you objectively weigh the risk of any loan with the potential benefit.