Business Magazine | BABM l Banking

Beginning or expanding a business can be an exciting venture. But to do so successfully, a business owner is going to need capital. That comes from either the owner’s personal check book or financing extended through a bank. To secure financing through a bank, a business owner must understand the 5 C’s of Credit. These guidelines are used by financial institutions as a way of analyzing a borrower’s request for a loan. The 5 C’s, Cash Flow, Collateral, Capital, Character and Conditions, are the major elements a bank uses to examine a business and its owner during the loan process. Each can have an impact on a funding request.

A business owner may feel he needs additional capital to run a business, but he must also demonstrate the ability to repay the loan being considered. In determining this, a bank will analyze the “EBITDA” ratio which looks at a business’ Earnings Before Interest, Taxes, Depreciation and Amortization. Broadly speaking, it’s the measure of the cash flow generated by a business. This is the cash flow available to repay the debt once the company has met its other payments required to sustain the business.

A bank may also be interested in how much capital has been invested by the owner, which requires calculated risk. Financial statements and personal credit reports or statements assist bankers in knowing how much an owner’s personal resources can support the business as it is growing. For companies that have yet to make a profit, elements such as an excellent customer list and payment history also come in to play. Bottom line: the business should be perceived by a bank as solid.

Bankers also look at collateral, or the secondary source of repayment. Collateral are assets offered by a company as an alternate repayment source. Typically these assets include real estate, accounts receivable, inventory, and equipment. In a liquidation scenario, accounts receivable can be used to pay down a loan, while equipment and real estate can be sold to generate income to pay down the loan as well. Until a business is established, a business owner will need to pledge collateral that may be linked to personal assets, such as a house. No one wants to be in the position of losing a home because a loan has not performed. A business owner needs to think carefully about how he or she will handle the collateral element when borrowing money from a financial institution.

Banks essentially are looking for sufficient equity in the company on the part of an owner. Sufficient equity can aide a business when times are soft. It’s important a company be able to sustain itself during tough times. Additionally, banks want assurance that an owner is truly invested in the company and will do what it takes to turn things around if cash flow becomes a problem. When examining capital, banks typically analyze the company’s total liabilities compared to equity, or the Debt to Equity Ratio. Most banks like to see the Debt to Equity Ratio no higher than 2 to 3 times.

It’s not hard to understand why investors want to invest with those who possess impeccable references and credentials. This is where the character of the loan applicant comes in to play. While the character card can be challenging to assess, a bank will carefully review business and personal credit reports, as well as communicate with vendors regarding a business owner’s dealings with them. Owners need to demonstrate that they are indeed effective leaders and can conduct themselves professionally in challenging times. Securing a business loan from a bank is based on trust, to a large extent. Banks need to know that a business owner will act in good faith at all times to honor any commitments.

Bankers must always take a look at current economic conditions surrounding a business as well as issues surrounding its industry to determine key risk factors. It’s important, therefore, for the owner to make evident the ability to manage these risks to ensure the future viability of the business. Banks will examine the competitive landscape of the company, customer and supplier relationships, and other industry factors that may impede the company’s growth. Business owners should be prepared to describe the primary threats to the business and what measures are being taken to protect the company from these risks.

The 5C’s of Credit form the backbone of a bank’s analysis when considering a request for a loan. A clear understanding of the bank’s requirements should help a loan applicant be prepared to provide appropriate information and successfully position the company in a way that results in the approval of a loan for the future growth of the business.

Rita Lowman is the Executive Vice President / CAO of American Momentum Bank. American Momentum Bank is a progressive Florida-based bank that strives to offer a deep understanding of our commercial, and retail clients’ immediate and long range goals. For more information, please visit www.americanmomentumbank.com.

The 5 C’s to Success – Securing a Business Loan With A Bank