Credit Analysis: The 5 C’s of Credit
Whether you are seeking to refinance existing debt, acquire a business, finance a succession, expand or gain working capital, a bank or lending institution will be interested in both your business and personal financials. To determine the risk associated with making a loan, a lender will perform a credit analysis.
Credit analysis by a lender is determined by the “5C’s”: credit, character, capacity, collateral, and condition.
• Credit: As history is the best predictor of the future, a lender will examine the personal credit of all borrowers and guarantors. Good personal credit is a must. Any problems must be thoroughly explained.
• Character: Lenders need to know the borrower and guarantors are honest and have integrity. Additionally, the lender needs to be confident the applicant has the background, education, experience, and industry knowledge to successfully run the business.
• Capacity (cash flow): The business should have sufficient cash flow to support its business expenses and debts comfortably while providing the principals’ salaries that will support personal expenses and debts.
• Collateral: A lender will consider the value of the business’ assets and the personal assets of the guarantors securing the loan as a secondary source of repayment if the loan cannot be repaid. Collateral is an important consideration for a conventional loan, but not as imperative with an SBA loan.
• Condition: The lender will need to understand the condition of the business, the industry, and the economy. Are current conditions likely to change, deteriorate, or improve?
The five components that make up a credit analysis help the lender understand the owner and the business and determine credit worthiness. By knowing each of the “5 C’s,” you will have a better understanding of what is needed and how to prepare for the loan application process.