The 5 Case of Commercial Credit
Just like any loan institution commercial lenders are in the business to make money. The most important factor to any lender is to ensure that any money it has made in loans is paid back. The commercial loan lender must consider the 5 of Credit each time it makes a loan.
Capacity to repay is the most critical of the five factors. Any prospective lender will want to know exactly how you intend to repay the loan. The lender will consider the cash flow from the business, the timing of the repayment, and the probability of successful repayment of the loan. Payment history on existing credit relationships both personal and commercial is considered an indicator of future payment performance. Prospective lenders will also want to know about your contingent sources of repayment.
Capital is the money you personally have invested in the business and is an indication of how much you will lose should the business fail. Prospective lenders and investors will expect you to contribute your own assets and to undertake personal financial risk to establish the business before asking them to commit any funding. If you have a significant personal investment in the business you are more likely to do everything in your power to make the business successful.
Collateral or guarantees are additional forms of security you can provide the lender. If the business cannot repay its loan, the bank wants to know where is a second source of repayment. Assets such as equipment, buildings, accounts receivable, and in some cases, inventory, are considered possible sources of repayment if they are sold by the bank for cash. Both business and personal assets can be sources of collateral for a loan. A guarantee, on the other hand, is just that €” someone else signs a guarantee in addition to the collateral as security for the loan.
Conditions focus on the intended purpose of the loan. Will the money be used for working capital, additional equipment, or inventory? The lender will also consider the local economic climate and conditions within your industry and in other industries that could affect your business.
Character is the personal impression you make on the potential lender or investor. The lender will decide subjectively whether or not you are sufficiently trustworthy to repay the loan or generate a return on funds invested in your company. Your educational background and experience in business and in your industry will be reviewed. The quality of your references and the background and experiences of your partners and/or employees will also be considered.
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