A simple explanation of how business credit decisions are made

Most business owners have applied for a loan and faced rejection or an insufficient solution. Often they don’t know why they are being successful or unsuccessful in the endeavor to borrow money. While many make the process feel like rocket science, the fundamentals of commercial credit are actually quite simple. Lenders call it the five “C’s” of credit.

Character

Admittedly, it’s hard to judge a person’s character you don’t know. That said, there are some key measures lenders evaluate that present the potential “character” of the business relationship. While there could be a number of items, the follow are the most common:

• Pay history
• Personal Credit
• Tax History
• Time in Business

Capacity

How much can you borrow? What is your capacity to take on and repay debt? Capacity is simply where your lender calculates a number of important factors to answer these questions. These factors include:

• Revenues
• Earnings history
• Cash flow
• Leverage (think of it as debt to worth)

Collateral

Often the easiest to understand…the equipment. If the lender is financing a new excavator that will have resale value for 20 years, that’s a good thing. If the lender is financing software, the finance options will be more limited. Secondary market value is very important to lenders when looking at the overall picture.

Capital

It’s easiest to think about this category as a description of how much investment you have in your company and the asset you are financing. If you have a significant investment in your company (especially as compared to how much debt you have) that’s typically viewed better than using everyone else’s money to fuel your business. Also, when acquiring equipment if you have equity (through trade or cash) in the new purchase that also add strength to the situation.

Conditions

The general business environment makes a difference. Everyone remembers what the “Great Recession” did to some industries. Not pretty. Even if a company in those industries was strong in other areas, the general environment could negatively affect the situation to a degree.