Be Prepared for a Smoother Business Loan Application With the 5 Cs of Credit

Being ready to navigate any economic climate is an important aspect of running a business, and securing appropriate financing to take your business forward can be a crucial part of your success. With a few strategic moves, you can open opportunities to steer you closer to your goals, whether you’re considering leasing or purchasing a new space, purchasing equipment or hiring additional staff. 

While some business owners may have the perception that there are “easy” or “difficult” times to approach lenders, that’s not necessarily the case. In 2020 — the most recent information available at this writing — banks nationwide issued nearly $462 billion in small business loans, an increase of 10% over the previous year, according to Community Reinvestment Act reports. Before Paycheck Protection Program (PPP) lending, small business loans were growing at a rate of about 4% a year, the Small Business Administration (SBA) reports. 

A banker can be a strong partner as you undertake the process of obtaining financing. Your banker can discuss what types of lending might be options worth considering, such as SBA loans, conventional loans, equipment financing or loans against assets — like inventory or accounts receivable. 

Before they lend to a borrower, banks seek to mitigate lending risk by a thorough evaluation of a borrower’s credit. Based on several factors — known as the Five Cs of Credit — this evaluation helps a lender determine the likelihood that a borrower might default on the debt. To prepare yourself and your business before seeking financing, here’s what to know about the Five Cs.

Conditions

Banks make decisions against the backdrop of current economic conditions, and they look at the broader circumstances surrounding your business and the loan. This can include interest rates, loan terms and the strength or weakness of the overall economy. Bankers also take into consideration the reason a borrower wants the loan, whether for working capital, equipment or expansion.

Character 

Credit is essentially a portrait of a borrower’s character and reliability. How have you managed debt and repayment in the past? Lenders examine patterns, including on-time payments, closed accounts, responsible credit utilization and history of bankruptcy, if any. A strong credit history lets the bank know you are a good candidate for a loan.  

Part of this assessment includes a review of your personal credit score. If you know your score could use some polishing, it’s wise to focus on raising it before applying for a business loan.

Capacity

Banks assess your capacity to repay a loan. That’s why it’s a good idea to apply for only the credit you need. You might also wish to bear in mind your debt-to-income (DTI) ratio — in some cases, banks are prohibited from issuing loans to borrowers with a DTI of 43% or higher. The bank may also review your company’s cash-flow statements to understand how much income your operations generate and analyze the amount of debt outstanding compared to the revenue you expect to generate each month.

Capital

Do you maintain a healthy cash reserve? Lenders look at your company’s balance sheet and consider how much the business owner has invested in the company. A borrower with skin in the game has a strong incentive not to default on a loan. And in the event that revenue doesn’t cover an occasional debt payment, capital can be a means to keep making regular payments.

Collateral 

Securing a loan with underlying assets, such as equipment or accounts receivable, can mitigate risk for the lender. Generally, banks have more opportunities for loan applications that list collateral than those that do not. Not only does the presence of collateral tell a bank that your business has a solid foundation, but the lender knows it can claim the asset should you default on a loan. 

The better prepared you are before completing an application, the easier it is for a lender to approve financing. Your trusted banker can discuss the Five Cs of Credit and advise you on your options and opportunities. Whatever your goals are for your business, a loan can help you make them a reality. To learn more about your credit options, contact your Western Alliance Bank relationship manager.