Your possibilities for business financing are influenced by the five C’s of credit: character, cash flow, capital, conditions, and collateral

Many lenders employ a framework known as the “five C’s,” or characteristics of credit, to assess possible small-business borrowers. These criteria are character, capacity, capital, conditions, and collateral.

Your eligibility for small-business loans is influenced by each of the five Cs. However, various lenders could give one attribute a higher priority than another. Understanding your company’s relative strengths and weaknesses can be beneficial because there are no hard and fast rules. This is especially true when it comes to things like growing business loan interest rates, which are beyond your control.

The five C’s of credit

• Character.

• Capacity/Cash flow.

• Capital.

• Conditions.

• Collateral.

1. Character

What it is: Character, the first C, more specifically refers to credit history, which is a borrower’s reputation or track record for repaying debts. A lender’s estimate of a borrower’s general creditworthiness.

Why this matters? Any history of timely and complete debt repayment is desirable to lenders.

How is it evaluated? From criteria including your credit history, credentials, references and engagement with lenders.

How to make it stronger : The most crucial aspect of this C will probably be your personal credit, so be aware of what lenders will notice. A brief overview of your borrowing and repayment history can be seen on your personal credit report. Because most lenders need you to personally guarantee the debt, which means you have to repay it if your firm is unable to, lenders want this information.

2. Cash flow and Capacity

What is it? It is Your ability to repay the loan.

Why does it matter? Lenders seek proof that your company makes enough money to cover the entire amount of the loan.

How is it evaluated? From financial measures and benchmarks (debt and liquidity ratios, cash flow statements), credit score, borrowing and payback history.

How to make it stronger Pay off debt before applying for a bank business loan if you’re concentrating on getting additional cash flow.

Consider cash flow loans, which give priority to your cash flow when evaluating your application, if your other Cs are weak but your cash flow is good. Bank statements and merchant accounts are examples of documentation that cash flow lenders would want to evaluate; nevertheless, they won’t put as much weight to your credit history or time in business.

3. Capital

What it is: The sum of money that a borrower can put towards an investment.

Why this matters borrowers who have contributed some of their personal funds to the business are more likely to receive funding from lenders. Borrowers who can put a down payment on a home, for example, typically find it easier to receive a mortgage – It implies that you have some stake in the outcome.

How it’s assessed: From the amount of money the borrower or management team has invested in the business.

How to make it stronger According to a 2023 U.S. Chamber of Commerce survey, about 70% of small business founders utilise their personal savings to launch their venture.

To ensure that you can trace any personal investments you make in your firm later, make sure to appropriately categorise them in your accounting software.

4. Conditions

What it is: In addition to examining income, lenders look at the general conditions relating to the loan. This may include the length of time that an applicant has been employed at their current job, how their industry is performing, and future job stability. The state of your company, including whether it is expanding or contracting, and the intended use of the funds. It also takes into account industry developments, the status of the economy, and how these could impact your ability to repay the loan.

Why this matters Repayment of loans by enterprises can be ensured by operating in favourable conditions. Lenders seek to recognise hazards and take appropriate precautions to avoid them.

How is it evaluated? based on an analysis of the market environment, supplier and customer dynamics, macroeconomic factors, and industry-specific problems.

How to make it stronger You can attempt to prepare ahead, but you have no control on the economy. But apply for a line of credit in advance, while your finances is strong. That will give you access to flexible financing down the road if your business’s conditions change.

5. Collateral

What it is: Resources utilised to safeguard or ensure a loan.

Why this matters As a safety net in case the borrower is unable to repay a loan, collateral serves.

How is it evaluated? from tangible assets like machinery and real estate; operating capital like inventories and accounts receivable; and the borrower’s house, which is also definable as collateral.

How to make it stronger: Recognise the possibilities available to you for collateral. Although real estate is frequently used as collateral for loans, other corporate assets such as automobiles, equipment, inventory, and accounts receivable can also be used.

KEY TAKEAWAYS

The five Cs of credit are used to convey the creditworthiness of potential borrowers, starting with the applicant’s:

• Character, which is their credit history.

• Capacity is the applicant’s debt-to-income (DTI) ratio.

• Capital is the amount of money that an applicant has.

• Collateral is an asset that can back or act as security for the loan.

• Conditions are the purpose of the loan, the amount involved, and prevailing interest rates.