The 5 Cs of credit, in plain language

01

Capacity

Can the business afford the payments?

Capacity is the business's ability to repay the loan out of its own cash flow. A lender starts here because cash flow is the first way a loan is expected to be repaid. If the business can't carry the payments in a normal month, the rest of the application rarely matters.

To judge it, the lender looks at what the business brings in, what it costs to run, and what it already pays on existing debt, then adds the payment on the new loan. They want to see enough left over to cover all of it with room to spare, because sales dip, costs rise and customers pay late. Bankers usually measure this with a debt service coverage ratio.

An established business shows capacity through its financial statements. A startup shows it through projections, and the lender will test every assumption behind them.

What helps

• Year-end financial statements that show a profit after all expenses
• Room in the numbers for every loan payment, old and new
• For a startup, a realistic forecast you can explain line by line

Related terms: Cash flow · Monthly revenue · Existing debt payments

02

Character

Will you do what you say?

Character is the lender's judgement of you as a borrower. For a small business, and especially a new one, there is usually little business credit history to go on, so the lender looks at how you have handled credit personally, even when the business is incorporated.

Experience counts too. A lender is more comfortable when the people running the business have done this kind of work before. How you present yourself matters as well: complete, consistent paperwork and a clear explanation of your own numbers build trust quickly.

What helps

• Payments made on time, every time
• Credit card and line of credit balances kept well below their limits
• A credit report you have checked for errors
• Relevant experience, or a partner, manager or advisor who brings it

Related terms: Credit score · Industry experience

03

Capital

How much of your own money is in it?

Capital is the money you put into the deal yourself, often called your equity, down payment or cash injection. Lenders rarely finance the full cost of a project. Your own money shows commitment, and it means the lender isn't carrying all of the risk.

Lenders expect that money to be in a bank account before they advance anything, not money you hope to raise later. Money you've already spent may or may not count, so ask your lender before you spend it. A loan from family or a personal line of credit usually doesn't count, because it's still debt.

Capital also includes what you and the business have built up over time. A healthy net worth tells the lender there is a cushion if the business has a slow stretch.

What helps

• Your down payment set aside in a bank account, untouched
• A clear record of where that money came from
• A personal net worth statement ready to hand over

Related terms: Equity / down payment · Personal net worth

04

Collateral

What backs the loan if things go wrong?

Collateral is the security behind a loan: assets the lender can take and sell to get its money back if the business can't repay. Bankers call it the second way out. Cash flow is the first way a loan gets repaid; collateral answers the uncomfortable question of what happens if the business fails.

The asset being financed is usually the main security, such as the equipment, vehicle or building the loan pays for. Lenders often also take a general security agreement over the business's other assets, like inventory, receivables and equipment. They favour tangible assets that are easy to value and sell, and they usually count them at less than full value, because a forced sale rarely gets top price.

In a small business, the owner's own assets are often part of the second way out too. That's why lenders so often ask owners to sign a personal guarantee, which makes you personally responsible for the loan if the business can't pay it.

What helps

• A list of what the business owns, with current values
• Current values for your home and other major personal assets
• A clear answer on whether you, and any partners, will sign a personal guarantee

Related terms: Business tangible net worth · Personal net worth

05

Conditions

Does the loan itself make sense?

Conditions cover the loan itself and the world around it: how much you want, what it's for, the rate, how long you'll take to repay it, and the state of your industry and the economy.

The amount, rate and term together set the payment, and the payment is what your cash flow has to carry. Lenders also try to match the term to what you're buying, so the loan is paid off before the thing it bought wears out. Asking for the right amount over the right term can be the difference between a loan that fits and one that doesn't.

What helps

• Quotes for what you're buying, so the amount is real
• A list of what you need financed, with amounts and any tax
• A term that fits how long the purchase will be useful to the business

Related terms: Loan amount · Loan term · Typical loan terms