The Six C’s of Credit
A strong relationship with your banker and knowing how credit decisions are made can improve your chances of getting a loan. Applying for a bank loan can be a frustrating and mystifying experience for small-business owners. Here’s a brief guide to what makes bankers tick and some tips to help you navigate their world.
The main concern bankers have is protecting their capital, money with which their depositors have entrusted them. Consequently, bankers are generally very conservative. Their first priority is to recoup the principal of the loan. Their next priority is to earn a reasonable rate of interest on the loan. And their third priority is that you prosper and open more accounts with them. Safety of principal is paramount. Bankers are not in the risk business.
Your job is to provide the banker with as many reasons to feel safe as you can. You start with a loan or financing proposal–a statement of what you need, why you need it, when you need it, and how you plan to repay it. The documentation should include a description of how much you need and what you’ll do with the loan, up-to-date balance sheets, cash-flow pro formas and projected income statements. All banks have forms to help you prepare these, but using your own business plan increases your credibility.
What do bankers look for when considering a financing proposal? The “Six C’s of Credit” provides a start.
The Six C’s of Credit
Character: Personal character is most important since all loans to small businesses are personal loans. The bank’s experience with you is critical. The judgment on the character of an individual is based on past performance. Personal credit histories as well as business credit histories will be reviewed.
Capacity: This is figured on the amount of debt load your business can support. The debt-to-net-worth ratio is often used to justify a credit decision. A highly leveraged business with a high debt/net worth ratio is perceived as less creditworthy than a company with low leverage. Here is where your business plan can make a difference. Suppose it shows that the loan will increase earnings and lead to a swift reduction in the debt/net worth ratio. Your chances of a positive answer would increase.
Conditions: Economic conditions, both regional and national, have a profound effect on credit decisions. If the bank is persuaded that a depression is coming, it won’t extend credit easily.
Collateral: Collateral is a secondary source of loan repayment. They want the loan repaid from operating profits and inventory so you become a bigger, better borrower and depositor.
Credibility: Do you know your business? Can you be counted on to be level-headed? How credible are your plans? A business plan helps you answer the banker’s questions without hesitation, sending your credibility rating soaring.
Contingency plan: A contingency plan is a useful financing tool. Bankers like to see that you look ahead. A contingency plan proves forethought. A contingency plan is a short worst-case business plan that examines the options that would be open to the business and how those options would be treated. Decisions made in panic are poor decisions. A contingency plan avoids panic.
Follow the Six C’s and you’ll be on your way to a prosperous business and protection for your future.