How to utilize the 5 Cs of credit to build and establish business credit

Understanding the five criteria that lenders use to evaluate your company is one thing—knowing how to use them to get a business loan and build business credit is another. These tips may help you better use the 5 Cs to secure the capital your business needs.

1. Capacity

What to do: Show that your business can pay back the loan by maintaining financial records that track current cash flow, profits, and expenditures. Careful recordkeeping and solid financial management practices can help you demonstrate your company’s ability to repay the loan.

Tip: Before applying for a loan through a bank, try to pay down any debts and calculate your current cash flow so you understand where you’re starting from.

What to avoid: Limited cash flow into the business. If owners don’t have enough cash on hand to handle principal payments after expenses and taxes, commercial lenders will be less inclined to extend a loan. Failure to keep accurate records could be another pitfall for business owners. Lenders rely on financial documents such as past tax records, income statements, balance sheets, and cash flow statements to see how well an applicant has managed finances in the past.

2. Capital

What to do: Diligently save capital or profits that you can reinvest in your business, especially as you’re starting out. By doing this, your lender can see that you have another source of revenue.

Tip: Invest money in your business and earn some profits before applying for your loan. This demonstrates your commitment to your business and your belief that you can make money from it.

What to avoid: Being impatient. Capital builds over time and requires patience to generate enough revenue for a down payment on a major purchase.

In order for your business to thrive, it’s important to sell products, receive payment, and fulfill obligations like replenishing inventories. But sometimes customers may be slow to pay, or they’re out of sync with your accounts receivables cycle. To fill those gaps in funding, try to build a cushion by saving several months’ worth of revenue. 

3. Conditions

What to do: Write a letter of intent to your lender that outlines why you need the loan and how you plan to use it.

Tip: It's hard to predict economic conditions, so it’s best to be prepared. If possible, apply for a business line of credit when your business is thriving so you can use it later if you need it.

4. Collateral

What to do: List all your potential forms of collateral—such as equipment, fleet vehicles, or business-owned properties—that could help you secure a business line of credit or a loan. Include your assets’ current fair-market value so a bank can accurately assess your business.

Tip: Some lenders want certain types of collateral—ask your lender what those are up-front.

If you’re using collateral for funding, it’s important to remember that lenders will only loan a percentage of it. For example, if a company’s collateral is property valued at $10,000, the bank may only lend 70% to 80% of the property value.^{Disclosure 1}

What types of collateral do lenders prefer? Real estate collateral tends to be viewed favorably because it retains value well over time. Investments are another common form of collateral that lenders will accept since they’re liquid and can be sold off quickly. Extra cash on hand—either in your business or personal bank accounts—is another commonly accepted form of collateral due to its liquidity.^{Disclosure 2}

5. Character

What to do: Maintain open communication and transparency with your potential lender about your business practices and your employees’ experience and qualifications.

Tip: Establish trustworthiness with your lender by sharing good business news with your banker—for example, if your business hits a monthly sales record or you’ve received compliments from customers on your employees’ service. This can help lenders continue to see your business in a positive light over time.