Master The 5 C’s of Credit

All business owners know that cash is the life-blood of their business. You might not be in the position yet to borrow funds to expand the business or smooth out cash flow irregularities, but chances are you may need funds in the future to support growth plans, hire new employees, upgrade equipment or even weather a slow business cycle. Therefore, maintaining a good relationship with a banker and a healthy Line-of-Credit is vital. Keep in mind that anticipating the need for credit well in advance will put you in a much stronger position not only to secure a loan, but also to negotiate competitive terms.

Many business owners ask, “What will the bank look for to loan my business money?”  It truly boils down to: “The 5 C’s of Credit”:

Cash Flow: How is your cash flow? This is basically your company’s capacity to pay back your loan. Banks perform a Debt Service Coverage (DSC) analysis based on your historical P&L. They usually require a DSC ratio of at least 1.20 to 1.00 – $1.20 of cash for every $1.00 of monthly debt service. This analysis is usually a two-year look back, and unfortunately does not take into consideration projections. Banks usually define “cash” as net earnings before taxes, depreciation and amortization, plus any one time or unusual expenditures. Your business’s cash flow tells a lender how much debt your business can successfully handle and how much cashflow is left to be reinvested into your business.

Character: This is evidence of your willingness to pay back your loan. Good character is seen through a solid credit report. Your credit score reflects your ability to handle your personal finances, so lenders assume if that’s good, it means you will also be able to handle your business finances well. As soon as you apply for a business loan, expect the lender to do a soft credit pull. This won’t harm your credit and will tell the lender only your credit score and a brief summary of your credit report. The better your credit score is, the more loan options you’ll have  available to you. You’ll want to aim for a credit score of at least 600—and even higher, ideally.

Collateral: The nature of the collateral is often predetermined by the loan type. Collateral is an asset that a lender accepts as security for a loan. If the business owner borrows money and defaults on the loan payments, the lender can seize the collateral and resell it to recoup the losses. If you’re applying for an SBA loan or bank loan, lenders will want to know what kind of collateral your small business has and its value. Most small business loans today require the personal guaranty of anyone with more than a 20% ownership in the business.

Capitalization: This refers to how much money you’ve put back into your business. Bankers want to see that you have a financial commitment and that you’ve put yourself at risk in your own company. How you capitalize your business can have long-term effects on your company’s success. Funding expenses, inventory, and operations are challenges for many business owners. It’s important to understand and explore the options available along with the risks and rewards.

Conditions: The conditions refer to economic conditions and how they affect your industry. The banker will evaluate the current economic climate and if there could be any potential near term negative impact to your company. As history shows, these conditions change over time, along with business cycles, as an economy goes through periods of expansion and contraction. For example, indicators like new orders for manufactured goods and new housing permits indicate the pace of future economic activity as it relates to the rate of manufacturing and the output and housing construction. Other indicators that can forecast future economic conditions include the consumer confidence index, new factory orders and business inventories. These are all tell-tale signs of the health of the economy and its impact on a business.

This is just a starting point for considering your possible need to secure a business loan. There’s a lot more to learn. Every business has different needs, and no financial solution is one size fits all. Your personal financial needs and vision for your business will shape the financial future of your business. B2B CFO® can help! Not only will a B2B CFO® provide guidance to help you through the process of securing capital to fund your business growth, but many of our Partners have solid working relationships with bankers.
Visit www.b2bcfo.com to learn more.