Small Business Loans - The Five C's of Lending - Page 2

Capacity: 
In evaluating the capacity of the business to pay back the loan, the lender is simply looks at the guarantors ability to pay back debt past, present and future, the timings of repayment and the probability of a successful repayment of their loan.  Excessive credit inquiries, high debt ratios and joint versus individual credit will be looked at along with business knowledge, experience in the industry and a sound business plan.

Cash Flow:
 “Cash is King” is often heard in lending and financing circles and it points to the fact that as long as a business is generating enough cash to pay it’s obligations and survive, it will sooner or later be successful in its respective industry all other things remaining the same.  Typically lenders look for a debt service coverage to be 1.25x (times) of the debt service – thus if the annual debt service for the business is  $75,000 the business has to have at least $93,750 of free cash flow for the bank to look at the deal in a positive light.  Each lender has their own debt service coverage requirements so check with your banker.  When evaluating cash flow a lender will consider the off balance sheet debts, personal debts for the business owners and partners, accounts receivables and accounts payables, the payment terms for the vendors, the sources of inventory and supplies and what credit they extend to the business and of course the use of the loan monies being applied for.

Character: 
The fifth element of the lending world is a lot less understood by business owners / partners. It is the most subjective element and it is where a well thought out business plan can perhaps help out the most.  Lenders want to know that the business that they are lending to is trustworthy and that they are committed to growing, expanding and being profitable.  They look for consistency in the information being provided, their ability to verify the information being provided and how quickly their requests for further documentation are being met by the borrowers.  Business and personal references play a big part in evaluating business character and the business owners and partners would be well advised to have a good board of directors or advisers who can add authenticity to their enterprise and ethics.

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