Featured RD: The 5 C's of Credit

Statistics show that most new businesses are undercapitalized.  A small line of credit may be the “Jump Start®” that you need to get your business going. A National City Bank representative shared this with me when I applied for a line of credit to expand my previous business.  With the credit crunch, it may be difficult to secure small lines of credit.  Don’t give up!  Be persistent. Your loan officer should consider the whole package, not just one aspect of what is described below:

The 5 C’s of Credit

If you pass each of these tests, you are considered low risk for lending.  Remember, risk determines loan approval as well as loan terms.

Character:   Personal credit history demonstrates tendency to repay debt in a timely manner.  The easiest way to measure a person’s tendency to repay debt is by their personal credit score such as the Fair Isaac Score used by banks. There are often mistakes in credit reports.  Check yours over carefully.

Cashflow:         Cashflow quantifies the capacity to repay debt.  Because the owner is essentially the business, both your personal financial situation and the business financial situation is used in determining the cash flow.  The formula for cash flow is:

Collateral:  Collateral is the security of the loan that acts as the payment of last resort.  Short-term assets such as accounts receivable or inventory secure short-term loans.  Long-term loans are secured by long-term assets like equipment or real estate (harder in today’s market) but not by highly depreciable assets such as cars or computers.  Collateral is discounted (i.e. 80% loan to value: collateral worth $10,000 will adequately secure a $8,000 loan).

Capital: Capital takes two forms: the amount of equity pledged for a project or the amount of net worth retained in the business.  The more capital that is retained or pledged, the more comfortable the bank is in making the loan.

Conditions:   Business conditions analyzed include the strength and weakness of the business as well as the opportunities and threats of the economic environment.  The owner’s experiences in managing a business and operating in the industry are also analyzed.   Business that operate profitably for more than two years are considered much less of a risk than start-ups.