When a small business applies for a business
loan, a bank or other lender follows a certain protocol when evaluating the application. One thing the bank uses is the 5 C's of credit analysis to evaluate the application for the loan. Bankers evaluate the small business in the context of the 5 C's in order to allocate their limited funds. Make sure your loan application addresses each of these points in detail and you will be more successful in getting your funding.
1. Capacity
In the opinion of the bank, the first "C", capacity, may be the most important. Capacity refers to the ability of the firm to repay the loan. In your loan application, you must discuss exactly how and when you intend to repay the loan. Not only do you need to state your revenues and expenses, but you also need to indicate the amount of your cash flows and the timing of your cash flows with regard to repayment. Capacity also refers to your credit history. Do you have a good credit score? The bank will look at your past repayment history, both business and personal. Don't forget to indicate every possible source of repayment at your disposal in your application.2. Collateral
Collateral is a distinct relationship to capacity. Collateral refers to forms of security you can provide to your bank or other lender. Collateral may be buildings or equipment owned by your small business or by you personally, including your home. Collateral may also include a guarantee by someone else that, in case you cannot repay the loan, the other party will. As money gets tight in the economy, there is an increased chance that banks will require loan guarantees in addition to collateral. You may know loan guarantees by the term "co-signer."3. Capital
Capital is the money you have personally invested in your business. This is the money you have at risk if your business fails. It is also your measure of confidence in your business. The amount of confidence you have in your business is important to your banker as is your willingness to take risk on your business. The amount of capital you have invested in your business is also an important measure of your ability to repay your business loan.4. Conditions
Conditions are two-fold. First, conditions refer to the overall economic climate and external environment surrounding the bank and the business firm. During a recession or periods of tight credit, it is obviously more difficult for a small business to repay a loan and more difficult for a bank to find the funds to loan. It becomes even more important for the small business firm to present an iron-clad loan application to the bank. The second part of conditions refers to the intended purpose of the loan. Are you buying new equipment for expansion? Are you replenishing working capital to prepare for seasonal inventory buildup? Why do you need the money? Spell it out in detail in your loan application.5. Character
Character is often a subjective judgment made by the banker about the prospective client. The lender decides if the client is trustworthy with regard to repaying the loan and generating a return on the investment. This is where the education and experience of the client comes into the picture. Your references and background in your industry are considered.
