Understanding your lender’s perspective is key to securing a business loan. When reviewing a Working Capital Loan Application, lenders assess your SME based on a few critical factors. The 5 Cs of Credit is a benchmark commonly used by lenders to determine the credit worthiness of potential borrowers.
In this article, we look at the 5 Cs of Credit and how you can improve on them. This will increase your chances of a successful Working Capital Loan application:
Character refers to a business’s reputation of trustworthiness. Having a solid credit history is a good indication. It reflects your ability to run a profitable business. For young SMEs with minimal business credit history, your personal credit score as a business owner is critical. If your business has been operating without credit history, we recommend that you start building your business credit score. It will come in useful in future loan application for expansion purposes.
Ways to improve your credit history are ensuring timely repayments, leaving a percentage of available credit unutilized and having a good credit mix. In addition to your credit history, lenders also look at the length of time in business. The longer you have been in operation and profiting, the lower the risk perceived. A fair amount of management and ownership experience is an added bonus.
The primary concern of a lender is whether your daily business operations generates sufficient cash flow for repayments. Most lenders require you to provide cash flow statements and projections. Another common measure of financial health is Debt Service Coverage Ratio. It measures the relationship between the debt and income of your business. As a general rule of thumb, a ratio under 30% is favorable. Having a buffer allows your business to continue making timely repayments in times of financial instability.
There are a few ways to lower your Debt Service Coverage Ratio. The methods are: increasing your net operating income, decreasing your net operating expenses, and paying off existing debt.
Capital refers to how much money you, as a business owner, have invested in your venture. In other words, it refers to how much you have at stake if the business fails. A large investment in your business indicates that you are willing to take a personal risk. This in turn gives lenders the confidence to take the risk with you.
The key is to allow your lenders to see your commitment to the business. First of all, have a significant personal investment in the business. Next, highlight how you have been successful in utilizing your capital in investments. Back your success with figures i.e. increase in sales revenue. Lastly, communicate the purpose of the loan. Let your lenders know the detailed planning of how the loan amount will be distributed across business operations.
Collateral is an asset pledged to the lender. Similar to owner’s capital, collateral gives the lender assurance. If your business defaults on the loan, the lender can recover the debt by seizing and liquidating the collateral. To ensure that the collateral provides sufficient security, the useful life of the collateral is expected to meet or exceed the term of the loan. As an extra layer of security, most lenders loan only a percentage of the appraised value of the collateral.
Each lender has a set of requirements when it comes to collateral. Some lenders will require a personal guarantee. As there are no specific assets pledged, personal guarantee does not constitute a secured loan. However, it is important to understand that all of your personal assets are at stake if you fail to make repayment. At the end of the day, it boils down to the extent you are comfortable with offering as collateral to secure a loan.
A lender takes into consideration factors beyond the boundaries of your business. Factors include the global and national economy, industry trends, as well as legislative changes relative to your business. These factors directly affect the ability of your business in making repayments.
While you may not be able to control the aforementioned factors, you can improve conditions. A tip is to apply at the right timing. While it may seem counter intuitive, the best time to make a Working Capital Loan application is when your business does not need it. When your business and the economy are flourishing, you are likely to receive the most favorable terms.
All in all, aim to establish the trustworthiness and profitability of your business. The end goal of a lender is to receive timely repayments. If you are weaker in one aspect, compensate with your strength in the other 4 Cs.
Stay tuned for our final installment of this series – 5 Things to Consider When Choosing a Working Capital Loan Lender.