Do you know the four Cs of credit?

Recent economic conditions suggest that the economy has slowed considerably and some experts say that we have entered a recession. In times like these, banks are more likely to tighten their credit requirements. The inevitable consequence is that it can be more difficult for businesses to get credit.

Under these conditions, it is even more important that when business owners apply for a loan, they understand what the banks are looking for. They need to know and understand the four Cs of credit:

1. Capacity 3. Conditions

2. Guarantee 4. Character

Let’s start with the first C, Capacity – the demonstrated ability to repay. Be clear! Banks are dedicated to lending money. That is one of the main ways they make money. So, contrary to what it may seem, a bank wants to lend you money. In fact, banks need you as much as you need them. But with that said, a bank must also be sure that the business owner will be able to repay the debt. This is really the “meat and potatoes” of any loan.

Therefore, a bank will review the financial statements of a business owner to see if it can generate enough cash flow to cover both its current expenses and its new obligations.

Collateral is another C speaking out loud to a bank. In my role as a business banker, it often amazes me how business owners often fail to appreciate the importance of collateral. Keep in mind that banks are security conscious; so having a guarantee helps the bank feel more secure.

Also, having collateral can substantially lower the cost of borrowing. Every business has guarantees, be it accounts receivable, inventory, equipment, etc. These are your assets; so use them to your advantage. When you sit down with a banker, be sure to discuss collateral.

The third C is Conditions. Banks also find it prudent to carefully observe current economic conditions when deciding to extend credit. They will examine the industry you are in and how it is affected by those conditions. A slower economy does not mean that a bank will not lend you money; it simply means that they are more careful in their credit practices.

Another important factor is where your business is in its growth cycle. Banks generally want to see two years of business data before they consider lending you money. Your business still doesn’t qualify? There are steps you can take to position yourself and be considered credible. Talk to your banker and ask him to do a thorough review of the financial reality of your business. Use your banker as you would your accountant.

The fourth C is Character. JP Morgan, one of the most successful businessmen in the world, once said, “I will do business with anyone as long as I am honest!” The key is understanding how a bank defines character.

Banks assess your character by your past performances – how you handle your financial, business, and personal affairs. Banks want to see that you understand how to run the business of the business. After all, would you give credit to someone who has a history of late payments, no payments, and defaults?

Remember that no matter how good your cash flow and cash position is, a bank will quickly reject your application if your credit history is poor. Clearly, then, the smart business owner will ensure that his business dealings also develop good character and integrity.

Finally, given the high cost of doing business in today’s global economy, the question is not whether your business will need credit, but when. Therefore, it is essential that entrepreneurs have a good understanding of what banks are demanding in exchange for their loans.