Understand credit’s 5 C’s to make your banker a friend

By Rick Arthur     

Is your bank a friend—or a foe? The lending practices of banks is a topic of concern to all small business owners—especially during economically trying times. But if you understand how banks do business, you can take steps toloan make your banker your financial friend, not your enemy.

As providers of the capital small businesses need to grow or expand, banks are cautious about how they lend their money, particularly in today’s economy. How do they determine who gets a loan and who doesn’t? Essentially, bankers follow the guidelines of the five C’s affecting credit:

1. Character. Yes, character counts. The bank checks your business’ credit report. It looks into your past decisions as well as into what results those decisions have yielded. The bank wants to know the personal and professional background of the owners and managers on your team and how well they relate to financial and business management. To assess this, they look into how well you and the team have handled your financial affairs in the past.

Although “character” is the most subjective of the five C’s, you can influence this evaluation by reviewing both business and personal credit reports, preparing bios for owners and key managers, and providing both business and personal references.

2. Capacity. The bank looks at your company’s past performance and future forecast to make a determination if it has the capacity to repay the loan within the term requested. As the bank does an analysis of financial statements, it pays particular attention to past, present, and forecasted cash flow and profitability. It reviews all of the numbers from all perspectives and validates figures. Because of their importance, financial statements should be professionally prepared. 

In today’s lending environment capacity has become the most critical component in the lending formula: the ability to repay the loan from future cash flows. The company will need to submit two years of tax returns both company and personal; two years of financial statements plus the most recent financials. Although the bank will prepare its own forecasted cash flow analysis, it is important to include your own version to the bank.

3. Collateral. The bank protects its money by asking for collateral, which are generally assets of the company requesting the loan. Collateral is almost always deemed to be a secondary form of loan repayment and will be based on discounted values of the underlying collateral. Because your bank needs to know the value of the collateral, you will need to provide documentation to support the balance sheet value (for example, accounts receivable—an aging report by customer and inventory—a detailed listing by item for both cost and market value). If the collateral is real estate or machinery, an independent appraisal of value may be requested by the lender. 

4. Capital. The bank wants to know if you, the owner, have risked your own resources by investing in the business. In the process of determining your credit, it validates your business operations to determine if the capitalization currently supports operations and debts and to see if the business has a sufficient buffer to help handle difficult times and/or seasonal variations. 

5. Conditions. The bank prepares a clear assessment of the economic conditions, regional markets, industry situations, and seasonal variations among others that might affect the future success of the business. It is important that the borrower provide their own analysis of trends within their industry and any pertinent local economy information that would influence the banker’s decision. Once this is completed, the bank outlines the terms and conditions under which it will grant a loan.

One of the conditions is almost always the business owner’s personal guarantee. The bank’s business logic is simple: If the owner isn’t able and willing to risk his or her personal assets, why should it put its assets at risk?

Keeping your banker your friend

If you and your business pass muster and the bank grants you a loan, keep it your friend:

• Make the bank your one-stop-shop. In fact, the bank will probably expect more from you than just the repayment of the loan. It will most likely require a depository relationship as well as the opportunity to provide treasury and other value added services. While this is normally a quid pro quo in the banking relationship anyway, it is becoming mandatory in the present banking environment.

• Meet regularly. To keep and maintain the positive relationship you have now developed with your banker, make sure to meet with your banker regularly and keep him or her apprised of the good, the bad, and the ugly concerning your present business position and outlook. If you’re looking to make dramatic changes, make sure your banker is “in the loop.” By keeping constant communication ongoing with your banker, you are assuring him or her that you care about your business, your finances, and their money.

Rick Arthur.smallRick Arthur is a partner with B2BCFO®,, a CFO firm servicing the needs of businesses with revenues under $75 million. With loans averaging $1.8 million, B2BCFO® partners are helping clients find cash to fund growth and create jobs in today’s economy. He can be reached at or 904-477-8957.

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