The Five C’s of Credit Evaluation
You need or want to borrow money to expand or start or upgrade your business. It could be a new piece of equipment, real estate, or a line of credit. Regardless of what you are borrowing you will likely be evaluated by some form of what is known as the Five C’s of Credit. They are: Character, Capacity, Capital ( Cash ), Collateral, and Conditions. Let’s look briefly at each one.
Character refers to the borrowers reputation. How have they repaid past loans? Do they pay on time? Any bankruptcies? Felony convictions? Foreclosures? The answers to many of these questions are available to the public. Good repayment history of loans of similar size is beneficial. Timely payment of credit cards is very important. Keeping total debt at a manageable level in addtion to the aforementioned are indications of good Character.
Capacity refers to one’s ability to repay the loan. Steady, adequate income, high net worth of real assets, and a solid amount of liquid assets ( cash, stocks, etc) that are available to repay a loan in addition to the business’s cash flow reduce the risk to the lender and increase the likelihood of a loan.
Capital is the amount of assets, usually Cash that will be invested in the business by the borrower. Also referred to as “having skin in the game” it shares the risk of the loan with the lender to some degree.
Collateral is the asset or assets that are being pledged to secure the loan. Typically it is the asset that is being purchased. Buying some new washers for your laundry? The loan will be collaterized by the washers to the amount of loan ( sale price less capital ). If there is a slow pay on a credit report more collateral may be required.
Conditions reflect the terms of the loan and the overall economic conditions that exist. As we see in today’s economy loans are hard to come by during recessions due to poor economic conditions.
Before applying for a loan take a quick inventory of your Five C’s. Look at your loan through the eyes of the person who will make the decision.