5 criteria in order of importance that banks analyze when applying for a commercial loan (the 5 “Cs” of credit)
Banks and financial institutions that lend money to a business are based on several criteria in order of importance
Temper
From the outset, honesty between two parties often lays the groundwork for a good business relationship, but otherwise, if no trust can be established, business relationships become extremely difficult and often abort.
The first important element when evaluating a potential client is the character of the borrower , ie the quality of the leaders and their willingness to pay. A company that has a quality administration will find it easier to have constructive exchanges with a bank and thus seek credit. After all, in the more or less long term, a company in difficulty which is managed by a competent administration has a better chance of success than a profitable company managed by an unqualified administration.
In this case , qualitative information takes precedence over quantitative data . This information is the first step that opens up a business relationship.
Ability
In second place in order of importance is the ability to repay . This criterion is necessarily the element that will decide whether a company is able to manage a loan. This point is based primarily on the company’s ability to generate revenue and profit , and this is calculated by going through the income statement (revenue, costs, profit) and cash flow (cash flow).
A business that fails to generate revenue and profits will never be able to meet its credit commitments. Also, a business that generates a large turnover but stretches its sales on credit and does not manage to get paid quickly, will have a cash flow problem and will have difficulty paying its debts on time. We must remember that only cash can repay debts.
In the case of a new business that is launched on the market, the banks ask to provide the business plan and a forecast cash flow to be sure of its ability to repay. However, the level of education and the experience of the leaders play a decisive role in obtaining access to a commercial loan in the case of start-up companies.
Capital
this case, financial institutions dissect the financial ratios (working capital, debt ratio, gross profit margin, etc.). This part is often the part that occupies the most time for the credit analyst, because we are looking for to assess the company over the longer term .
We measure the solvency of the company , that is to say the coverage of the assets on the liabilities. A company that has accumulated a large amount of profits over its lifetime will be better able to get through difficult times and face deficits, and therefore will be more favorable to obtaining credit.
Also, a bank will be more comfortable with a company that has been generously financed by its shareholders. Typically, financial institutions require shareholders to finance more than 25% of assets. Below that, the banks feel they are bearing the majority of the risk and will ask shareholders to inject more money into the company.
Terms
There are also other factors that can influence the performance of certain companies such as bad weather, natural disasters, political decisions, wars, terrorist acts, to name a few. These are all aspects beyond the company’s control but which can be considered in a credit decision.
Collateral
The collateral is the last element in importance. By collateral we mean the guarantees that a lender has recourse to if the borrower defaults. A financial institution seeks to secure itself on a company’s assets by becoming the owner of inventory, equipment, furniture, buildings or even vehicles. Consequently, the bank will be able to recover part of the amount of money that remains to be paid on a loan in the event that a customer stops making payments.
This is the last aspect in importance because, when a bank is made to seize the assets of the company to pay itself, it has in most cases suffered a loss. The loss is collected when it must initiate legal proceedings to recover the assets; the procedures are expensive and the bank may well not cover the full amount. Also the bank considers a loss by the opportunity cost, that is to say that it could have used this money and invested it in a less risky client and generate profits.
Collateral is considered primarily to minimize loss in the event of default , but not as a criterion for accepting a loan.
