Understanding the 5 C's of Credit

The 5 C's of credit are factors used to score loan applications, but what do they mean?

1. Character

Character is your willingness to take on debt and commit to repayment on the agreed upon terms with other lenders. This information is often determined by a review of your Credit Bureau reports which can show both your business and personal credit history. If your business is newer, your personal credit history will be more heavily relied upon so it's important to periodically review your credit history for accuracy.

2. Capacity

Capacity is your ability to take on lending. Banks often use the Global Debt Service Coverage Ratio (GDSCR) to assess your capacity for taking on debt, and each bank may have their own unique GDSR calculation methods. Generally speaking, GDSCR includes taking your combined business and personal cash flow and dividing it by your annualized debt obligations and coming up with a ratio before considering a new loan request. If your ratio is more than one, this means your business is taking in more money than the money going to service your debts. A ratio of less one means your business is not taking enough cash and it may be time to restructure or pay-off debt.

Some other things to consider regarding GDSCR calculations include:

  • Your business cash flow can include net income, depreciation, amortization and interest write offs
  • Your annualized expenses can include payments for existing obligations (principal and interest)
  • In times of economic uncertainty, you may find banks raising the GDSCR ratio to avoid higher risks of defaults. You can ask your banker what the typical ratio they would like to see from a borrower
  • To complete these calculations, you will need up-to-date financial statements and/or tax returns. If you do the calculations yourself, get a second review by your Banker or CPA.

3. Capital

The bank will evaluate the cash position of you and your company and your ability to liquidate other assets if it were necessary to support your loan obligation if your business hit a rough spot.

4. Conditions

This tends to be a very industry specific analysis of the conditions that would encourage stability or pose a risk to repayment of your loan obligation. Having a well thought out business plan that identifies the risks and mitigations helps your bank understand your preparedness to address these challenges.

5. Collateral

Collateral refers specifically to what assets your business is willing to pledge in order to secure a loan. Small business owners are often asked to provide a personal guarantee in the event the business is unable to pay the loan. 

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