Everybody understands the importance of establishing a solid credit history. Business owners are particularly reliant on a good credit portfolio.
At some point, your business will need capital, often for growth or expansion, and your business’s financial history is likely a defining factor. Understanding the 5 C’s of credit will help you better present yourself to lenders the next time you need to apply for financing.
What Are the 5 c’s of Credit?
When lenders consider your eligibility for funding, they typically use the 5 C’s of credit to determine your creditworthiness. They may assign a rating for each one, create an overall value for your credit reliability, and use that to determine appropriate credit limits and interest rates. The 5 C’s are character, capacity, capital, conditions, and collateral.
1. Character
Lenders define your personal or business character by evaluating your credit and financial history. Do you make payments on time and often more than the minimum required amount? Do you manage your finances well? For example, if your business uses less than 30% credit, you likely manage your finances more efficiently than a business using 90% credit.
Some aspects of your credit history that make up your character include:
- Ratings from financial institutions, such as banks and credit rating agencies
- The names of current and past lenders
- Your payment timeline
- Any outstanding payments
- The type of credit you have
Most lenders evaluate using a FICO credit score because it consolidates your history across several reporting agencies.
2. Capacity
Your capacity to repay a loan is based on your business revenue. Your debt-to-income ratio may affect the amount of funding you could receive. If your current debt is significantly higher than your generated revenue, you may find it challenging to get business financing.
3. Capital
Capital is the total of your assets, including savings and investments. The more assets you could liquidate, the better your capital rating. For example, if you own any property that you could sell quickly during a financial setback, you appear more creditworthy.
4. Conditions
Conditions refer to all the surrounding factors that affect your application. How you plan to use the funding should you receive it plays a role. Lenders need to assess the outside risks involved as well. Some questions they may consider include:
- What is the state of the current economy?
- What are the federal interest rates?
- Is there any legislation specific to your industry that could affect your intended use of the loan?
- Is there an important election coming up that could create political changes?
When the overall economy is struggling, even businesses with a strong financial history may not be able to access the financing they want or need.
5. Collateral
Most lenders require some form of collateral to secure a loan. If you borrow money to buy a second business location, you need assets in your name to lessen the risk for the lender. In such a case, you would likely use the commercial space as collateral. If you default on payments, the bank may repossess the commercial space and sell it for the value of your loan. The same is true for a business vehicle loan or business equipment financing.
How Hard Is It To Get Funding For Your Business?
There is no simple answer for how difficult it can be to get the funds you need for your business. It depends on various factors, and the requirements are different for different lenders. There are also many types of funding available; your chances of qualifying will vary based on the type of financing you choose. The following are factors that lenders consider when you apply for business financing:
- Length of time in business. The longer you have been in business, the less risky you appear to lenders. Online and alternative lenders tend to focus less on your time in business, but overall, the more established your company is in the industry, the more reliable you appear.
- Your financial statements. Lenders want to see that you have a steady flow of revenue. A strong cash flow tells the lenders that you can make payments even when your business is in a lull. Many financing applications require full disclosure of your business financial statements.
- The amount to be financed. Your cash flow and revenue directly affect the amount of funding your business is eligible to receive. Some lenders will increase the financed amount if you have substantial collateral to secure the requested funds.
You can request an amount on your application. If the lender denies that amount, you will likely still qualify for a lesser amount. Once the lender conducts a complete evaluation, they will determine what they deem appropriate to offer. You can accept or seek funding elsewhere.
How Can You Improve Your 5 C’s of Credit?
If you want to improve your profile for the future, consider the following tips to help you improve your 5 C’s of credit and appear more creditworthy to lenders:
- Increase the credit limits for your current lines of credit. Your credit utilization rate shows borrowers how responsible you are with available credit. A good credit utilization rate is no more than 30% of available credit.
- Boost your savings. Your asset profile appears strong when you increase the number in your savings account.
- Do not open too many new accounts or credit cards. If you open too many lines of credit in a short period of time, lenders see you as a greater risk.
- Make early payments. Early payments improve your credit score more rapidly than on-time payments.
As you search for business funding options, consider online funders and weigh the pros and cons of the different types of financing. Whether you need a commercial business loan or something more specific, such as equipment leasing, you can find funders that support your qualifications.
For more information on how we can help you get the financing your business needs, visit Platform Funding.
Sources:
- https://www.forbes.com/advisor/credit-score/5-cs-of-credit/
- https://www.navyfederal.org/resources/articles/small-business/the-5-cs-of-credit.html