Ever wonder how banks determine what small businesses get approved for a loan? Surprisingly enough it comes down to a basic set of criteria that have been utilized in the banking industry for decades. They are called the 5 C’s of Credit.
While it isn’t all an exact science, these five components do hold weight on decision making, so bear this in mind when trying to put your best foot forward.
1. Character is important because it gives the bank an indication of who you are and if you are trustworthy enough to repay your loan. The bank is looking to determine how you have handled your previous obligations. They are asking themselves these types of questions:
- Do you pay your bills?
- Do you have lawsuits against you?
- Do you have a criminal record?
- How is your credit score?
All of these will help determine if you are responsible and keep your commitments to others in which you do business.
2. Capital that you have invested could help or hurt you as well. Banks want to see how much money you have put into your business to determine how serious you are about ensuring it goes well and produces a profit. Questions they are asking include:
- How much have you invested in the business?
- How involved or invested is your management team?
- How would your life fair if the business failed?
- How have you shown that your business is a priority?
3. Capacity touches on the notion that if given a loan, you have the ability, or capacity, to pay it back.
- Do you have any debt?
- What is your repayment history?
- What do your cash flow statements indicate?
4. Conditions can work in your favor or against you as well. These are factors that include outside sources like the state of the economy and future predictions of your industry. Many of these can be outside of your control but nonetheless, and understandably so, must be evaluated as well. A bank will look at:
- How have economic or consumer changes affected your industry?
- What does your competitive landscape look like?
- What percent of the market share do you own?
- Do you have positive supplier and vendor relationships?
- Does your business have any partnerships that could result in a conflict?
- What are potential risks to your business?
5. Collateral makes the most sense when looking into if a small business owner can repay back a loan because if the money must be collected, the bank needs a backup way to get it. Your collateral will have the bank asking:
- How much are your other assets worth (inventory, real estate, equipment, etc.)?
- What percentage of your loan would your assets cover?
- What potential conflicts or barriers would there be to selling the assets?
- Are your personal assets protected or can those be seized as well?
As a small business owner getting a business loan from a bank can be a tricky process. Know that there are steps that you can take to help assure the bank that they are making a good deal. Take a fine-tooth comb through your financial documents beforehand to increase your chances for success. By proactively doing so you can get the money you need to keep moving forward.