Access to capital is a challenge for many small business owners, and this is especially true for women and minorities. Typically, MWBEs have more difficulty getting loans from traditional lenders, and pay higher interest rates when they do. That’s why knowing what lenders look for and how they perform a credit assessment is especially important for MWBEs.
The five Cs of credit assessment represent the different aspects of your business that a lender will look at when determining whether to lend you money and what terms it will offer you. (More creditworthy customers present less risk to the lender and are typically offered a lower interest rate and longer repayment terms.) They are the basic components of credit analysis: the essential measures that, when taken in their entirety, allow the lender to determine with some level of accuracy your ability to repay the debt.
Arguably the most important of the Five Cs, capacity reflects your ability to repay the loan. When assessing capacity, a lender will look at income statements and balance sheets to determine if your business has the cash flow to successfully meet the terms you propose. Other factors in the credit assessment include your payment history with other creditors, the amount of any existing debt, and other sources of repayment available to you.
Capital represents your personal investment in your business. Obviously, if you have little of your own money invested, you have little to lose financially should the business fail. Thus, a lender is more likely to lend money to business owners who have a contributed a substantial amount of their own funds to establish the business and ensure its success.
Collateal is additional security that you provide the lender to guarantee that you will meet the loan terms. Collateral can be in the form of a tangible asset, such as your home or other real property, or a guarantee from a third party that they will repay the loan should you default (a co-signer or guarantor). If you are a business owner with little credit history or insufficient cash flow, it’s a good idea to find a guarantor in advance of applying for a loan.
Conditions is a general term that includes the purpose of the loan and market conditions that might affect repayment. The lender will want to know how you intend to use the money: for example, is it for working capital, equipment or additional inventory? At the same time, it will look at external factors that might affect your ability to repay, such as the conditions in your industry, the local economy, or supply chain issues that could impact your cash flow.
Although typically listed last, character is equally important to your overall creditworthiness as financial assets and cash flow. It is a subjective assessment in that the lender will form an opinion about your integrity and trustworthiness based in part on the experience of working with you. However, other quantifiable aspects of your business and business relationships will also come into play, such as your educational background, expertise in your industry, the quality of your business relationships, the strength of your firm’s leadership team and the references you supply.
The Bottom Line
Obviously, lenders are in business to make money, so their primary purpose in performing a credit assessment is to mitigate their risk. Thus, the more prepared you are to prove your creditworthiness, the more likely you are to get the funds you need as well as favorable loan terms. So, before applying for a business loan, get your ducks in a row by following these steps:
- Prepare financial statements meticulously. You should have an estimate of future earnings as well as documentation of your earnings for the last three to five years.
- Polish your business and marketing plans
- Update your resume and those of your key employees
- Run your personal credit report and clear up any outstanding issues, such as unpaid or overdue debts
- Know the value of your collateral. If you are pledging an asset, such as your home, you will need to prove to the lender how much it’s worth.
The Carmoon Group, Ltd. is a full service insurance broker headquartered in Hicksville, New York. Our professional staff has over 20 years experience providing business insurance and other financial services to firms or all sizes in various locations throughout the United States. Give us a call today to schedule an appointment for a free consultation, or, if you prefer, reach out online and we will get back to you right away.