Why should you follow the 5 C’s of credit?

While the post-crisis financing landscape has changed drastically and landing a business loan today is more challenging than it was, it’s far from impossible, especially if you make sure your business measures up to what bankers call the “five C’s of credit“:

Character

Banks don’t lend money to inanimate objects. They lend to business owners, and they usually want to know more about the owner than financial numbers. This means you and your management abilities. Do you and your key executives have a strong reputation in your community and industry? Do you treat your customers, vendors, and employees with courtesy and respect? This includes taking responsibility for your actions and the outcomes (both good and bad), as well as meeting all of your obligations, even when it might not be in your best interest.

Capacity

This means your company’s ability to safely assume more debt, a measurement known as debt-service capacity. Your banker will calculate a few key financial ratios with information culled from your financial statements to determine how much more debt your business can safely assume.

Capital

This refers to how much cash and hard assets your business has on hand. Your banker may calculate a measurement known as the cash-conversion cycle, a liquidity measure that combines several ratios derived from your financial statements.

The cash-conversion cycle will reveal how much working capital you need to run your business, without running out of cash. Also keep in mind that banks usually like to see that business owners are personally invested in their companies.

Sweat equity is one thing, but bankers tend to be more receptive to loan requests from business owners who have some skin in the game.

Collateral

Most business borrowers today will be required to pledge a secondary source of repayment, or collateral, in case they default on a loan.

Banks usually prefer hard assets (such as real estate and equipment) as collateral, because they can convert them to cash more easily if they have to, rather than raw materials or unfinished goods. If yours is a service business, you may be required to pledge personal assets- usually your primary residence- as collateral to support a loan.

Conditions

These are the economic conditions in the broad national economy, in your local geographic area, and in your specific industry. They will vary, of course, often considerably, in different areas of the country and in different industries.

While trade-exposed industries such as manufacturing and retail sectors are struggling in light of the strong Australian dollar, others- notably the resources industry- are booming, despite the overall sluggishness of the economy.