Tag Archive for: Business Credit
The Five C’s of Credit and How They Impact Business Financing Decisions
If you’ve heard of the five C’s of credit, you may assume that this phrase is only associated with personal credit; however, it’s also a tool used by lenders to evaluate businesses pursuing credit options.
Here’s why the five C’s of credit are important to your business; how lenders evaluate each of them; and how to best position your business when applying for financing.
What are the 5 C’s of Credit?
The term “five C’s of credit” refers to one way in which lenders evaluate the credit-worthiness of an applicant. It can be used for individuals and couples applying for personal credit such as a loan, credit card or a mortgage. But, it’s also used to help assess the “worthiness” of business credit applicants.
Lenders review how well a business meets each of the five C’s, and then use their findings to help make a lending decision.
1. Character
Character refers to the likelihood that a business will pay back borrowed money. Information for the Character portion of the five C’s of credit often comes from the history noted on a business’ credit reports. It will also include the business credit score generated from these reports. Business credit reports come from business credit reporting agencies such as Dun & Bradstreet, Equifax, and Experian.
These detailed reports contain particulars of previous borrowing arrangements – including total amounts borrowed and repaid, as well as delinquencies and late payments. The reports also include details of judgments, liens, and accounts in collections going back through seven years.
2. Capacity
Capacity is your ability to pay back the money borrowed from the proceeds of your business. Before a lender gives a borrower any money, they’ll want some evidence that the borrower (being the business), generates enough money to make payments on the loan. So Capacity is the proof that the business has the cash flow to not only make the payments, but to also cover all the business expenses, other debts and obligations, and pay the wages of its employees.
To evaluate a business’ capacity, lenders will review the financial statements and financial ratios of the business, including:
- Debt-to-Income Ratio (DTI)
- Debt-Service-Coverage Ratio (DSCR)
- Current Ratio
- Debt-to-Tangible-Net-Worth Ratio
- Inventory Turnover Ratio
- Accounts Receivable Turnover Ratio (ART)
- Payables Turnover Ratio
- Cash Flow Statement
- Income Statement
When it comes to evaluating business capacity, a lender may also consider your managerial capacity. This is your business knowledge and professional experience.
3. Collateral
Any lender faces the risk that borrowers won’t return the money they borrowed. So lenders look for ways to reduce that risk and secure their loan, which brings us to the third C of Credit: Collateral.
Collateral is any asset used as security for the lender. Lenders could seize secured business assets of value such as real estate, equipment, and machinery to sell and recoup some or all of the unpaid loan if the borrower can’t pay it off. For example, a business may get a loan secured against vehicles or a commercial building.
4. Capital
Another factor that influences lenders’ willingness to loan money to a business is the owner’s equity. How much of your own money have you invested in your business? Your “skin in the game” indicates your financial commitment to the business. This equity, referred to as capital, gives lenders an idea of just how risky the owners consider their own business. Generally, the more of your own money invested, the better it is in the eyes of a lender.
5. Conditions
The fifth C of credit is one that you have little control over, yet it also influences business lending decisions. The current macroeconomic and microeconomic conditions could impact a business’ ability to pay back a loan. So lenders carefully consider the economic environment as part of a lending decision.
Demonstrate that you have a good understanding of current (and forecasted) economic conditions, and how they’ll potentially impact your business by referencing them in your discussions and correspondence with your lender. This shows lenders you’re a forward-thinking and responsible business owner who is committed to growing your business through changing economic conditions.
Once you know about each of the 5 C’s of credit, you can better understand how lenders use them to make lending decisions for businesses. And you’ll have a better idea of what to watch out for, and what to work on when making financial decisions for your own business.
What is in a Business Credit Report?
Credit bureaus track business credit activity through your EIN (employee identification number); or, if you have one, your D.U.N.S. number. Business credit reporting agency, Dun & Bradstreet, issues this identification number, and it’s free for businesses that have to register with the federal government to receive contracts or grants.1
This information helps build your credit report, which contains details on reported past and current borrowing arrangements. These include loans, credit lines, credit cards, and mortgages. The report may also include information on judgments, liens, and any accounts that may have gone to collections agencies. Your business credit report will also include a credit score, which generally represents how the issuing agency views your business’ ability to make payments on time and in full.2
How Lenders Use a Business Credit Report
Lenders use the information in your business credit report to help inform financing decisions for credit applications from businesses. They may take into account your business credit score, payment history, length of credit history, and any derogatory or negative information.
Why You Should Request Yours
It’s important to see the information on your business credit report to ensure that it is accurate. If you find that it is not, contact the reporting companies to have it corrected. Incorrect information could negatively impact your next loan application.
Seeing what lenders will see on your report can also give you the opportunity to prepare to explain any unusual or less-than-desirable information on your business credit report. And it also gives you an idea of areas for improvement, such as paying bills on time or keeping credit card balances within limit. These steps will make it easier to qualify for business financial vehicles like a term loan or business line of credit.
7 Business Credit Report Providers
If you’re curious about what’s in your business credit report, check out these seven providers. We’ve included five that offer reports for free.
#1. Experian
One of the better known personal credit bureaus in North America, Experian, also offers paid business credit reporting services. Experian offers a one-time business report which includes a credit summary report, credit score, and business summary for one business. Or, you can choose a monthly or annual service with the ability to check your own business credit reporting and business information. Through the service, you can also check details on other businesses (such as your existing or potential customers).
#2. Equifax
Operating across the globe, Equifax offers an entire suite of business credit reporting services for businesses large and small. While they don’t currently offer a free report checking service, their Business Risk Monitor for Small Business Service provides Public Record, Credit, and Risk Score email alerts to notify customers of activities and inquiries impacting their business credit in these areas.
#3. Dun & Bradstreet
The CreditSignal site operated by business credit bureau giant, Dun & Bradstreet, lets you monitor changes to your Dun & Bradstreet business scores and ratings — for free. It also notifies you either through email notifications, or via an app, when someone else requests access to your business score. However, take note — to get your actual business credit score you’ll need a paid subscription.
#4. Nav
Credit monitoring system, Nav, gives both individuals and businesses access to free credit summaries. Check your business report summaries from Experian and Dun & Bradstreet — you don’t even need to provide a credit card number to do so. Yet, bear in mind that these are only summaries. If you want access to more detailed business credit information, you’ll need the paid service.
#5. Credit.net
Although free access to your report through the Credit.net website is limited to a seven-day free trial, it’s a good place to start if you want to get a look at your current business credit situation, plus check credit summaries on others. During this time you’ll have access to seven reports. With the extra reports, you may want to consider checking credit reports on customers looking for credit terms with your own business.
#6. CreditSafe
Here’s another online option that lets you access a free report before committing to a longer-term paid arrangement. With a customized CreditSafe free trial, you’ll have access to credit scores and limits, company financials, adverse credit insights and more for not only your own business, but other businesses as well.
#7. Tillful
Tillful is on a mission to help small businesses reach their full potential by giving them free access to their credit score so owners know where they stand when it’s time to get business financing. With the Tillfull business credit reporting ecosystem, you can access your credit score and learn how it’s measured. You can also connect as many bank and business credit accounts that you want to get a holistic view of business credit. You can access this system as often as you’d like and you can even sign up for email monitoring alerts to let you know in real-time when a change has been made.