credit analysis

The Five Cs of Credit Analysis for Small Business Owners

A bank’s decision to lend money to a borrower is not rocket science. It’s a decision made on the basis of a few founding principles, so to better understand how they decide who is approved and who isn’t, let’s look through the lens of the lender.


At the core of any loan process is a credit analysis to determine the risk associated with making the loan and the likelihood that the loan would be repaid. In business financing, it is not just a matter of evaluating the business, but also the person(s) associated with its ownership and operations. Most credit analyses use five categories to evaluate the risk of a loan: character, capital, conditions, collateral and cash flow.


Documents such as personal tax returns, personal financial statement (PFS), resume, business tax returns, interim profit and loss statements, balance sheet on business and a business plan help paint the picture of a borrowers five C’s. Here’s what those categories mean and why you should pay attention before you seek financing for your business.


Character: Can we trust you?

Your aggregate traits define your character. From each interaction with a lender, the bank is determining honesty and integrity. The lender needs to be confident the applicant has the background, education, industry knowledge and experience required to operate this business successfully. This all amasses to answer the question of “can we trust that you will be able to run this business successfully and be able to pay back our loan?”


Business owners have a personal financial history that can help paint a picture of their (likely) future behavior. There are many factors that influence loan approvals, and personal finances and credit can have a significant impact on your ability to borrow money for business purposes. A lender will examine personal credit analysis reports and PFS of borrowers and guarantors associated with the loan.


Your credit report is your track record of prior debt repayment. Your credit analysis report compiles your debt story in one place and tells a reader how successful you are at paying that debt back. Balances, credit limits and payment history are reported from your credit cards, student loans, mortgages, car loans or other lines of credit. Payment history is one of the largest factors in your credit score. It is wise to check your reports before talking to a lender; if there are any delinquencies, be prepared to explain.


Scores are based primarily on the following: payment history, revolving credit availability, age of accounts, collections, personal bankruptcies and liens and judgments.


Capital: What is your investment?

When asking to borrow money from a lender, it is only natural that they will ask what personal

Investment, or capital, you plan to make or have already made in the business. Contributing personal assets demonstrates that you are willing to take a personal risk for the sake of your business; it shows that you have ‘skin in the game.’ The amount needed varies depending on the size, use and type of loan you are requesting.


To assess your personal financial position, the lender will request a PFS. This is simply a summary of your assets, things of value you own, liabilities, debts or obligations. From these numbers, you are then able to calculate your net worth, which is assets minus liabilities. Depending on the lender and the type of loan, a positive net worth may not be a requirement to qualify for the loan.


Your PFS is also another indicator of your financial responsibility. The types of assets and liabilities that you accumulate begin to reflect long-term planning behaviors or short-term spending behaviors. Accumulating credit card debt even in smaller amounts can appear as a less favorable type of spending behavior than larger student debt balances used to invest in your education or a reasonable mortgage for a house. Savings are important as it shows the lender that you are living within your means. There is no silver bullet, and at every stage of your life, your PFS will be looked at differently.


Consider these two questions about your PFS. Does your PFS align with your past and current job positions? Does your PFS reflect a history of responsibility when it comes to managing your personal finances?


Conditions: What is happening?

This “C” represents the lender getting a grasp on what the money can be used for and the health of the industry. There are a number of things that factor into how the lender evaluates the conditions. The overall premise is that they are gaining a perspective on what the loan will be used for, what will be taking place, the status of the business, as well as the status of the profession and marketplace economy. Lenders like to see positive trends and strong business plans with a thoughtful plan for growth and continuity.


Common reasons for small business expansion financing include construction, renovations, acquisitions, succession planning, partner buyouts, real estate purchases, equipment purchases, working capital and refinancing.


Collateral: What if you don’t pay it back?

A lender is not just interested in what happens if everything goes well, they also have to consider the worst-case scenario. For instance, what happens if the borrower chooses not to pay back the loaned money?


Collateral helps solve this problem by acting as a secondary source of repayment. A lender will consider the value of the business’ assets and the personal assets of the guarantors as potential collateral for the loan. Collateral also acts as a psychological motivator, as people tend to get more resourceful when they have something to lose. Collateral is an important consideration, but its significance varies depending on the type of loan. A lender will be able to explain the types of collateral needed for your loan.


If your financing path takes you to Live Oak Bank, there is a great chance that the type of loan you will be receiving is a Small Business Administration (SBA) loan. This means that a percentage of the loan will be government-guaranteed and if the loan were to not be paid back, the government would guarantee the bank’s loss up to that percentage. There are many misconceptions regarding SBA loans (links to 5 Cs in each vertical blog), so it’s important to seek specialists that understand the SBA loan program.


Cash flow: How will you pay it back?

Ultimately to approve the loan, the lender wants to get comfortable with how your business will be able to successfully repay the loan. In business financing, there is a different paradigm in evaluating repayment ability than in consumer financing. With business loans, the repayment ability is coming from the performance of the business being evaluated. This capacity to repay comes from the business’s cash flow. This is the amount of cash available after ordinary business expenses have been paid. The business should have sufficient income to support its business expenses and debts comfortably while also providing principals’ salaries sufficient to support personal expenses and debts. Cash flow management is an imperative skill for any small business owner.



  • Revenue: The amount of money generated from business sales and activity. Also referred to as income, sales, or “the topline.”
  • Cost of Goods Sold (COGS): Cost of the materials to perform the services you deliver, and goods sold. This is the primary variable or direct expense for the business because it varies directly with sales volume.
  • Gross Profit: Money available for the company to meet its overhead and other general expenses.
  • Operating Expenses: General expenses of the business not directly associated with a sale. Also known as overhead costs or indirect expenses.
  • Net Income: The resultant dollar amount after all other expenses have been subtracted from gross profit.
  • Net Operating Income (NOI): A simplistic measure of the company’s cash flow available. Calculated by add-backs to net income.
  • Margin: Ratios created to translate dollar amounts into percentages to express efficiency.
  • Debt Service: Total dollar amount owed for principal and interest payments on debt.


Common Add-Backs

  • Compensation of current owner(s)
  • Interest
  • Depreciation
  • Amortization
  • One-time expenses and/or labor normalization
  • Rent (if purchasing the business’s real estate)