Banks and online lenders use the same set of fundamental metrics to evaluate an application for business funding commonly referred to as “The 5 C’s of Credit.” This long-standing approach allows lenders to consider the factors likely to influence a small business’s ability to pay back its financing. The 5 C’s are Capacity, Character, Conditions, Capital, and Collateral.

Your Credit-Risk Scorecard

Using the 5 C’s, banks and online lenders form a credit-risk scorecard for a small business. This scorecard helps determine whether a small business will be able to successfully manage the financing they are seeking. Some lenders use scorecards exclusively built with data gathered from credit bureaus. Others use a combination of scorecards and underwriters with small business lending expertise to perform a more thoughtful analysis.

Here’s a breakdown of each of “The 5 C’s” – what each means and how they are calculated.

1. Capacity

Definition: “Capacity” is defined as a measure of a business’s ability to continue operations and support cash flow while paying down its debts, particularly the new financing they are seeking.

How it’s Calculated: To assess a business’s capacity, lenders examine a business’s financial statements, including tax returns, accounts receivable statements, and accounts payable statements. The level of documentation a lender requests is often based on the size of the funding a business is seeking.

2. Character

Definition: “Character” is defined as a measure of the business owner’s history with both commercial and consumer credit. Banks and online lenders consider character as an indicator of whether a small business owner has been a responsible borrower and business owner in the past and how likely they are to be responsible in the future.

How it’s Calculated: Both personal and business credit reports provide lenders with helpful information. Positive signs that can improve a character rating include responsible repayment of loans and other debts. Red flags that can reduce a character rating include tax liens, bankruptcies, loan defaults, and missed payments. Some online lenders may also consider a business’s online presence and customer reviews.

Want to improve your credit risk scorecard? Visit our Resource Center and download How Lenders Evaluate Your Small Business: What You Need to Know Before You Apply.

3. Conditions

Definition: “Conditions” considers an applicant’s industry, geographic location, time in business, and the economy at large.

How It’s Calculated:

Industry: Industries with pent-up demand for a business’s products or services are likely to be rated as having strong conditions. A business in an industry where demand may decrease because of outside circumstances could result in a negative assessment of conditions.

Location: If a region is heavily dependent on a single industry or employer and that industry or company is facing difficulties, that can have a negative impact on a conditions rating. Natural disasters (or even being in an area prone to natural disasters such as wildfires or hurricanes) can also lower a conditions rating.

Time in business: The length of time a company has been in business and the strength of the business owner’s related experience can impact a conditions rating. Small businesses that have been in business longer and have weathered natural business ups and downs are likely to receive a higher conditions rating.

4. Capital

Definition: “Capital” is a measure of a business’s ability to support the amount of financing it applies for. It is presented as a total dollar amount of cash in a bank account across time.

How it’s Calculated: Lenders review current bank assets and invoices and other orders that provide insight into future cash flow. Businesses that keep enough cash in the bank to sustain operations for a period of a few months demonstrate to banks and online lenders that they have other means of payment in the event of cash flow issues.

5. Collateral

Definition: “Collateral” is defined as the tangible assets that can be liquidated to pay back all or some of a financing agreement in the event of default. Some lenders don’t require borrowers to offer their assets as secured collateral (which is called “unsecured financing”), but they will want to see that the assets are there in the event of default.

How it’s Calculated: Lenders might ask for an appraisal of existing collateral and the total amount of all assets that can be collateralized. This metric is presented as a dollar amount of all existing collateral, including equipment, real estate, and other assets.

Fraud & Small Business Lending

Lenders are also looking for fraud and indications of intentional misuse of credit in applications. Unfortunately, criminals commonly target financial services companies. Fraud can be detrimental to both lenders and legitimate borrowers. By carefully vetting out fraudulent applications, lenders can reduce their loss rates and offer better pricing to legitimate customers.

Now that you have a better understanding of the common metrics lenders use to evaluate a small business, you will know what to expect during the underwriting process for your business funding application.

Looking for more insight? In our guide, How Lenders Evaluate Your Small Business: What You Need to Know Before You Apply, we share 7 easy ways small business owners can improve their credit risk score and increase the likelihood of receiving funding with acceptable terms and pricing. Visit our Resource Center and download the guide here.

Our mission at Swift Capital is to unleash the potential of every small business by providing them with fair and convenient access to working capital. We harness data and technology alongside personalized human expertise to see the true potential in every business. Did you like this post? Tell us what you’d like to see on our blog. Email us at [email protected]


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