Examining the Four Critical “C’s” of Doing Business
When you ask for money from a lender, they’re going to look for a few things from you. These are normally known as the 3 C’s: Credit, Capacity, and Collateral.
Credit: You and/or your business need to demonstrate that you have a history of making timely payments when you owe someone money. That means that you and/or your business have a sufficient enough credit score to get the loan. This is often more important for a personal loan than a business loan. For a business, the next few “C’s” can make more of a difference in determining whether you get the loan.
Collateral: The lender often wants to see that there will be some kind of asset that secures the loan. In a business, this can be accounts receivable (what your customers owe you), equipment, real estate, or other assets your business currently owns, or will eventually purchase with the loan funds.
Capacity: Your lender wants to know that your business can repay the loan. They are going to look at the cash flow of the business, and various ratios such as your working capital ratio.
Before you head off to the bank, take a second look to see how your financial statements will look for the bank. Your lender will want to see collateral. What are you using as collateral for the loan? The most common are Accounts Receivable, and fixed assets like equipment or real estate.
If you’re using accounts receivable, the lender will want to see an aging of the amounts your customers owe you. This is a listing of all of the accounts, designated as to whether the receivables are current, 30 days old, 60 days, 90 days old, or older than 90 days.
Often the lender will not allow you to use accounts older than 90 days as security. The feeling is that if the account is too old, you don’t have as much certainty on whether or not it will get paid. They may also discount any accounts that are over a certain percentage for total business sales.
In this case, they are concerned that one customer that is too big could sink your company if they don’t pay. They may also ask you for history on accounts receivable write-offs. If you often write-down or completely write-off some of the accounts, then the bank won’t give you much credit based on those assets.
In the case of equipment, the lender will want to assess the fair market value for the assets. If the worst case scenario happens, and your business stops making payments, the lender will want to know that the assets have enough value to cover the loan.
As with any other part of the loan application process, you need to look at your financial statements and other reports that you give to your prospective lender. What story do they tell? Be ready for questions if you have less than ideal circumstances.
The final C is for Capacity. Does your business have the ability to repay the loan? If you need the loan because your business is failing, then there is a good chance that the lender will say no. As the old saying goes, “The best time to ask for a loan is when you don’t need it.”
Your financial statements should show that you have sufficient capacity to make the payments. One calculation they will look at will be the working capital reserve. The working capital reserve is calculated as the current assets, minus the current liabilities.
Current assets are the total of cash, cash equivalents, accounts receivable, and inventory. Your current liabilities are accounts payable plus the accrued expenses. When making this calculation, in addition to looking at how viable the accounts receivable are, the lender will also look at how fast the inventory turns. They won’t give you much credit for old or stale inventory.
Look at your financial statements like a lender would before you turn in your paperwork. Be prepared with answers to the questions you’ll get. It will go a long way to persuading a lender that you do understand your business, and will have the resources to repay the loan.