There are various definitions in the marketplace on what defines eligibility towards business credit, but the general ideas are the same. One thing to note is the order of the Five C’s in terms of least tangible to most tangible. It’s no accident that issues of Character and Credibility are the most important.

#1: Character
What kind of person are you? What kind of borrower will you be? Character is tough to measure so we have to use the best proxy available- your personal credit history. How have you paid back the people you said you would pay back historically?

Have you had just a single missed payment, which could happen to anyone? Or, do you consistently let your creditors wait until you’re ready?

Too many recent inquiries on your credit can also make lenders nervous. It could indicate that some other fire is burning in your life that you’ll need to explain. It’s often an indication that you may have taken on new debt that hasn’t yet showed on your credit history or the statements you provided.

What if you don’t have credit history? It makes it very difficult to borrow money from traditional sources. This might be where you ask your friends and family for a little help with your new venture.

Bankruptcy is another matter all together. If you’ve declared bankruptcy in the last seven years, you are going to find it very difficult to get anything but asset based (fully secured by cash, accounts receivable, real estate or equipment) financing.

#2: Credit
This is where your business credit history is analyzed. If you hear people talk about the need to have a D&B record (Dun & Bradstreet, http://www.dnb.com), this is it. D&B and Experion are the two large business information and credit rating services out there today. Be sure your business has a listing and your record is good. Lenders check to see how you have paid your trade suppliers and other business obligations.

Just like your personal history, if there’s anything we as lenders should know about, better to tell us in advance. We don’t like surprises.

#3: Cash Flow
Most lenders are “cash flow” lenders. Simply put this means the cash flow of your business is the primary source of repayment for the money you borrow.

How is cash flow computed? An overly simple example would be your Net Profit + your non-cash expenses (depreciation and amortization). The reason you add non-cash expenses is because you didn’t actually have to write a check therefore those “accounting charges” are available to service debt.

Lenders want some kind of a cushion. If your total loan payments were $1.00, a lender may was to be sure that your Net Profit + non-cash expenses = $1.50 or 1.5X your debt payment.

Sole proprietors are principally treated the same way, but often the debt-to-income (D/I) ratio is used. To compute D/I, you add up your personal and business loan payments then divide by the adjusted gross income on your tax return (plus non-cash charges like depreciation and amortization found on the schedule C of your 1040 tax form). The resulting D/I ratio usually needs to be less than 55%.

#4: Capacity
What would you do if your business plans didn’t pan out? Or if the business took a downturn and the business itself couldn’t service the debt? Do you have “capacity” to convert other assets to cash, by either selling them or borrowing against them?

Capacity is also called “Secondary Source” of repayment. Secondary sources include real estate, CDs, stocks and other sources of savings. A personal financial statement and business balance sheet reveal your capacity.

#5: Collateral
You’ll find secured and unsecured in the marketplace. With a secured loan, you put up collateral or the lender takes a lien. It might be personal assets like CDs, stocks and business assets (real estate, inventory, equipment, or accounts receivable).

Most business financing – not just small business -is secured.

To get unsecured credit, your business needs to be well established and consistently profitable. A personal net worth equal to or greater than your request is also desirable.

I sincerely hope that The Five C’s of Business Credit will serve your business in its preparation towards managing the financial health of your company.

In my next article, I will go into developing relationships with the bank. You will be surprised how many companies have no, or very little, relationship with their bank representative.

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