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The 5 Cs of Credit (article)

Contributors: Michael Caron  

Many business owners do not fully grasp the challenge facing lenders. Virtually no lender, banker, salesperson, business development officer, relationship manager or the person a business owner would work with to begin the loan process can make a decision on your credit request.

Back in the day, it was possible in some cases for a banker to make a lending decision. Today, the person you meet with to apply for the loan, your lender, will be the one to demonstrate your creditworthiness to a credit officer (the decision maker) who has not and probably will not ever meet you. The only thing the credit officer will have to base a decision on will be the paperwork evidence you’ve presented to the lender.

Ensuring your paperwork meets the minimum standards established by the credit officer will help demonstrate your creditworthiness. These standards can be broken down into the five Cs of credit.


Character generally is measured by a number of readily available reports that bankers pull. Within the reports, the lender looks for trends in payment history, as well as any derogatory information relating to the business and/or owner. Borrowers who do not demonstrate integrity in their past financial dealings will have a very difficult time getting reputable lenders to provide a loan on any terms. Keep in mind that personal and business credit issues, including bankruptcy, may be explainable.


Banks are not in business to take risk. When banks make loans, they generally look for collateral to help mitigate any perceived risk. Assets include accounts receivable and inventory, as well as real estate. In addition to the collateral securing the loan, personal guarantees are a usual and customary requirement for loans to privately held companies. Banks make unsecured and unguaranteed loans; however, borrowers who qualify for these loans are very strong financially and have a long history of financial success.


Economic- and company-specific factors that may influence the ultimate success or failure of the business are conditions. For example, evidence of pending sales, generally in the form of purchase orders or contracts, demonstrate to the lender that your claim of increasing sales in a down sales environment can be realized. Concentration risk is also a condition to consider. Many may contemplate the effects of a major customer decreasing sales or not paying invoices, but what if that customer increases its sales exponentially?


Capital includes retained earnings and money you or others have invested in (capital stock or paid-in-capital) or loaned to (subordinated debt) the business. Leverage, the ratio of debt to equity, is a key measurement taken by banks to assess the perceived level of risk inherent in a business. If you have too much debt relative to your overall equity and something goes wrong in the business, the highly leveraged business has less of a cushion to fall back on.


Capacity is the demonstrated ability to service the loan you are requesting. Insufficient cash flow is the fastest way to be declined for a loan. Lenders typically require coverage ratios of at least 1.10 times the loan’s minimum payment requirement. The higher the coverage ratio, the easier it is to qualify for a loan. Profit alone may not be adequate to demonstrate the ability to pay back a loan. Lenders look at a combination of numbers reported on your financial statements, including interest expense, taxes, depreciation, amortization and other non-cash items expensed.

Consider the Five Cs

Armed with the knowledge that lenders base their credit decisions on your character, the collateral, the conditions, your capital position and your capacity, you have a better understanding of the rationale they will use in approving or declining your request for credit.

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