When you apply for business loans, SME finance or business finance lenders may use the five C's of credit as a guideline for determining whether you qualify for financing. Sometimes referred to as the four C's, depending on the lender, these criteria are used to gauge your business's ability and likelihood to repay a loan.
If financing is on the horizon for your business, either to consolidate debt, fund an expansion project or simply cover working capital needs, here's what you need to know about the five C's.
What Are the 5 C's of Credit and Why Are They Important?
Lenders look at your personal and business credit scores as a condition of approval. Lenders can review your personal FICO and VantageScore credit scores. On the business side, they can check credit scores issued by Dun & Bradstreet, Experian and Equifax.
Lenders can go deeper than your scores, however, and use the five C's to get a broader picture of your creditworthiness.
What are the five C's of credit that lenders look at? They are:
-- Capacity
-- Capital
-- Character
-- Conditions
-- Collateral
Here's more detail on what each one means.
Capacity
Capacity refers to your business's ability to repay a loan based on your current cash flow. Lenders want to know that you'll be able to handle new monthly loan payments in addition to any other debt you owe and your everyday operating expenses.
Lenders may consider capacity by examining your monthly revenues and expenses, along with existing business debt and business assets, such as real estate, cash savings or investments. Business bank account statements, loan statements, accounts receivable and accounts payable can all be offered as proof of capacity.
The lender may want to know how easily you could liquidate assets if needed. In terms of business debt, the lender will look at how much of your business income goes toward repaying debt each month. The lower your debt-to-income ratio, the better.
Capital
Capital refers to how much skin you have in the game when getting a business loan. Often referred to as owner equity, capital could show that you have enough confidence in the profitability of your business to invest your own money. If you bootstrapped your startup from your own savings, for example, that can suggest to lenders that you're serious about repaying a loan.
If you don't yet have sufficient capital investment, lenders may ask for some. For example, if you're seeking financing to buy new equipment, the lender might require a down payment for approval.
Character
Character encompasses several different measures of your business's creditworthiness. Think of it as your business resume. It can include your business and personal credit scores, and also factors including your business reputation, education, professional credentials and your personal integrity. For example, if you're seeking a loan to open a new restaurant, lenders will want to know about your previous experience in the restaurant business.
Lenders may also ask for personal and professional references as proof of good character.
Conditions
Conditions are the state of the business and projections for future financial health. That can include individual business performance along with the industry as a whole. Conditions also consider loan use and how that benefits your business. If you plan to use a loan to buy equipment or inventory, for instance, the lender may ask for an explanation of how that will advance the bottom line.
Lenders can also look at how broader economic conditions or trends within your industry may affect your ability to repay a loan. Say you run an import business and want a loan to purchase more inventory. But new and potentially increasing tariffs could make profits thinner in the future. The lender will consider how that could affect your overhead costs, profit margin and cash flow, all of which can impact your capacity to repay a loan.
Collateral
Secured business loans, or loans that involve the purchase of an asset such as real estate or major equipment, typically require collateral. Putting up collateral means pledging an asset you own as a guarantee. If you default on the loan, the lender could use the collateral for repayment. The lender will want to have an accurate assessment of the collateral's current market value and its estimated resale value.
