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The "Five C's" of Credit Analysis
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Posted On: Friday January 30th, 2004 at 12:00am EST
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Do you know what the lender looks for when analyzing your loan package?
Regardless of where you seek funding - from a bank, a local development corporation or a relative -
a prospective lender will review your creditworthiness. A complete and thoroughly documented loan
request (including a business plan) will help the lender understand you and your business. The
"Five C's" are the basic components of credit analysis. They are described here to help you
understand what the lender looks for.
The 5C's
Capacity to repay is the most critical of the five factors, it is the primary source of repayment - cash.
The prospective lender will want to know exactly how you intend to repay the loan. The lender will consider
the cash flow from the business, the timing of the repayment, and the probability of successful repayment of
the loan. Payment history on existing credit relationships - personal or commercial- is considered an indicator
of future payment performance. Potential lenders also will want to know about other possible sources of repayment.
Capital is the money you personally have invested in the business and is an indication of how much you have at
risk should the business fail. Interested lenders and investors will expect you to have contributed from your
own assets and to have undertaken personal financial risk to establish the business before asking them to commit
any funding.
Collateral or guarantees are additional forms of security you can provide the lender. Giving a lender collateral
means that you pledge an asset you own, such as your home, to the lender with the agreement that it will be the
repayment source in case you can't repay the loan. A guarantee, on the other hand, is just that - someone else
signs a guarantee document promising to repay the loan if you can't. Some lenders may require such a guarantee
in addition to collateral as security for a loan.
Conditions describe the intended purpose of the loan. Will the money be used for working capital, additional
equipment or inventory? The lender will also consider local economic conditions and the overall climate, both
within your industry and in other industries that could affect your business.
Character is the general impression you make on the prospective lender or investor. The lender will form a
subjective opinion as to whether or not you are sufficiently trustworthy to repay the loan or generate a return
on funds invested in your company. Your educational background and experience in business and in your industry
will be considered. The quality of you references and the background and experience levels of your employees
will also be reviewed. |
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