The 5 C’s of Credit

Understanding the 5 C’s of credit can help small business owners who are looking to get a loan. Lenders are generally looking for answers to three questions:

1. Can you pay back a loan?
2. Will you pay back a loan that was given to you?
3. What will you be doing if an unexpected event occurs?

You may not be asked this question, but I would like to share the five metrics that many lenders use to evaluate your answers.

Lenders are generally risk-averse. (Some have a greater tolerance for risk than others, however). In an economics course I took many years ago, the instructor was very concerned that we understand the test questions and answers before the big test. The grade we received was based on how well the students answered the questions and not just if they got the right answers. He wanted us prepared and to learn.

Although it might seem a stretch, comparing my economics course with the process of applying for a loan for a small company could help you answer questions correctly and have your application approved.

What is the importance of credit?

Since years, lenders have been using a handful of metrics to assess borrowers. The 5 C’s are a handful of metrics that lenders have used for years to evaluate borrowers.

The Five C’s

Character or C #1 is an important factor in how a lender will evaluate you. In the past, I could go to my banker for a loan and receive a few thousand dollars depending on his opinion of me and my purpose. This type of lending to small businesses is less common, but it doesn’t mean that your character doesn’t matter.

I spoke to a friend of mine who is a local banker. He said that if the business has a strong management team, and some other factors are in place, then we can convince the lending board the company is a candidate for a small loan.

It doesn’t follow that the more tangible metrics aren’t important. She added, “There is a certain credit threshold that we will not go below. But we want to do the best we can for the small business in our community.”

You can’t just rely on your character to get you a loan. Remember, data drives loan decisions but it is your character that matters when the rubber meets the road.

C#, or your credit score does not really tell me much about your business’s ability to meet its financial obligations. But it says a lot about you. Your personal credit score is often used by lenders to decide whether or not they’ll even consider your application. Some lenders have different credit thresholds. The better your score is, the more options are available to you.

Lenders are evaluating your credit history and business credit profile to see what you might do in the future. If you have a good credit history, they assume you will continue to pay your debts in the future. The longer your history, the better.

It’s safe to assume that in today’s economy, credit problems that occurred during the current crisis (and will continue to be considered differently when the economic challenges related with the coronavirus end) are treated differently from a chronic problem that dates back before the outbreak. If your credit rating has been affected this year, it may be possible to get a small-business loan as long as your other metrics are good.

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HTML How Even if you don’t have experience as a business, a great deal of knowledge in the industry can be helpful. If you do not have a Business Plan you may want to create one. You can still be credible and confident even if the lender does not require it. A business plan can also help you develop a vision for your company.

*C #2, Credit Score: Before you speak to any lender, it is important that you know your credit score. You can access your credit score in a number of different ways. Navi is one of the many ways to access your score. The majority of traditional lenders will accept scores as low as 680, but they may sometimes lower it to 700. SBA requires a minimum score of 650, while some online lenders are willing to work with you as long as you have at least 600. Some lenders will even work with you if your score is as low as 500. However, the lower the score, the less options you have and the higher interest rates you’ll pay. You can find out your score and then look at the types of financing that you are more likely to be approved for.

*C #3, Capacity You may not be in a position to change your revenue or cash flow overnight, but it is possible to ensure that your accounting records are up to date and that any potential lenders have access to the necessary information to make a decision. Prepare to allow a lender to access your accounting records digitally and to accept data validation, if offered. It will not only help your lender to review your information but it will also make the process easier for you.

*C #4, Capital: Keep track of your Cash Flow. A poor cash flow management can make it difficult for you to obtain a small-business loan. It could also spell the end of your business. Lenders want to see a steady stream of monthly cash coming into your business from a variety of sources. You may find that your loan application is negatively affected if you are too dependent on just one or two clients.

*C #5, Collateral: There is no such thing as an “unsecured” loan in the business world today. However, there are lenders who do not require collateral for securing a loan. This type of financing is available to businesses who do not have collateral assets. You can streamline the application process by preparing a list of assets. You will need to provide a personal guarantee, regardless of whether you have collateral.

You can now take the necessary steps to ensure that your loan application is at the top of a list. It is not guaranteed that you will be approved for the loan, but you will find it easier to apply.