Deciding if and when commercial financing is right for your business can be a difficult decision. And on top of that, there are many types of credit options to choose from. According to a recent Wells Fargo study of small business owners and their use of credit, many small business owners have a limited understanding of what it takes to get credit and how best to use credit options. credit.
To help you understand how lenders will assess your credit application, we have identified five critical elements called the 5 Cs of credit: Credit history; Ability; Capital; Warranty and Conditions. Lenders can accept or deny applications based on these business credit requirements, so it’s important that you understand each one. Here’s a breakdown of the five Cs, along with some tips to make your credit application more compelling.
A strong credit history is essential for obtaining financing, as lenders want to see that you have an established financial record, as well as proof that you can repay a loan. A credit history will show a lender you’ve borrowed from before, how much you borrowed, whether you had reasonable balances, and whether you made payments as agreed. To manage your credit responsibly, it’s important to make your payments on time. With bank credit cards or lines of credit, keep your balances low against credit limits. And finally, create dedicated business accounts, because lenders will want to see how you manage your business and personal finances separately and responsibly.
Before providing financing, a lender will want to ensure that the business has the ability to repay a loan and meet its payment obligations. Profitability and cash flow are key to demonstrating that your business has the capacity to handle new credit. A business must have sufficient positive cash flow to meet short-term and long-term commitments, and a lender will carefully assess a business’s cash flow to assess the likelihood of repayment.
When a lender sees the owner investing money in the business, it shows that the business owner is determined to succeed. Additionally, a business owner whose assets can be turned into cash in the event of a sudden drop in income will be better able to operate their business and pay off their debts. A lender wants to ensure that the company’s assets sufficiently exceed its liabilities and understand how quickly and easily those assets can be turned into cash.
There are several internal and external factors, beyond your financial situation, that can affect a company’s ability to repay a loan. For example, on the external side, if a major recession is predicted and could negatively impact your business, lenders could factor that likelihood into their decision. On the internal side, the conditions include the borrower’s experience and business knowledge. In some cases, professional references and education are personal factors that may influence conditions. Internal and external conditions can be important indicators of a company’s ability to survive and prosper, and therefore its ability to repay its credit obligations.
Collateral, when required, can be used as a secondary source of repayment to a lender in the event of default. You may be able to qualify for a small loan – usually less than $50,000 – without collateral if you have a healthy credit history and financial statements. However, if you need to post collateral to secure a lender’s investment, it’s important to document your assets. These can be real estate, equipment or, in some cases, savings and deposits.
With a better understanding of the five Cs of credit, you will have a good idea of what it takes to prepare for credit and some of the basic steps to help you get there.
Brandon Meredith is Wells Fargo’s Small Business Leader in South Lake Tahoe. Get more tips and details about online small businesses at http://www.wellsfargo.com/biz.