How Much Do the Five Cs of Credit Matter?

The five Cs of credit are character, capacity, capital, conditions and collateral. These are the key criteria that bankers and other conventional lenders consider when processing a loan application. There isn’t a universal metric that lenders apply – some score points for each criterion, whilst others simply bear them in mind when reaching a decision. And of course, every lender sees things differently, so one might focus on collateral whilst another is more concerned about capital.

Carl Faulds

So what does each of the Cs really mean – and how do you measure up?

• Character

In simple terms, your character indicates how reliable, honest and trustworthy you are. Put another way, it indicates the level of the lender’s faith that you will pay them back. Your credit history will be an important factor in assessing your character, as it indicates a track record of good or bad behaviour. For many lenders, this is the most important criterion of all – everybody feels more comfortable doing business with people they trust, respect and like on a personal level.

• Capacity

Capacity – otherwise known as cash flow – indicates your business’s ability to repay the proposed loan. If your monthly outgoings are higher than your monthly income, then clearly you have no spare capacity to repay debt. Even if you do have spare cash, but only just enough, the lender may consider that your finances are too highly geared to represent a good risk – all it would require is a slight downturn in business and you would be unable to make your payments. As you might expect, the level of debt you already have is an important factor in calculating your capacity, so if you currently owe substantial amounts you are unlikely to be offered more.

• Capital

Capital represents the total amount of money invested in the business, and is used as a measure of your commitment to making it succeed. After all, if you haven’t put much money into it, you don’t stand to lose much if the company fails. Lenders will want to see that you have made sacrifices to get the business off the ground and keep it afloat – the more you’ve put in, the more you’re likely to do whatever it takes to keep the firm solvent and growing.

• Conditions

This is a bit of a catch-all, as it refers to two different things. First, it means the conditions surrounding your business: the health of the sector, the state of the economy, and any economic, environmental or political considerations that could affect its performance. Secondly, it concerns the way you will use the funds you wish to borrow, and how you will react to broader market conditions. If your business sector is sluggish, will you invest in a marketing campaign so you can power ahead? If good quality raw materials have become hard to obtain, will you use the extra cash to buy the best so you can deliver an industry-leading product? Your lender will be keen to see that you have the imagination and the vision to buck trends, enabling your company to remain in business whatever is happening in the wider world.

• Collateral

Your collateral is the security you can offer on your loan. It could be premises (if you own them freehold), plant or equipment, and it gives your lender reassurance that if you fail to repay they can seize and sell an asset to recoup their losses. Further, the lender will reason that since you stand to lose something of significant value, you will be more likely to keep up the payments and behave responsibly.

What if you don’t measure up?

But what do you do if you struggle to measure up – if you have a poor credit history, a marginal cash flow or no collateral to offer? Rather than giving up, you should talk to an alternative lender, who will apply different criteria when making decisions.

If you have good collateral but are struggling on the other four Cs, an alternative lender could offer you asset-based finance, where you borrow against the value of your premises, plant or equipment. Since the loan is secured, the interest rate will be competitive and the lender will be far less concerned about the possibility of default.

Meanwhile, an excellent way to tame a troublesome cash flow is invoice factoring or discounting. This innovative solution allows you to borrow most of the value of your invoices the moment you issue them, with repayment being made when your customers pay you. With factoring, the alternative lender will take over your debtor ledger and assign experienced credit control professionals to secure early repayment, thus minimising the amount of interest you pay, whilst with invoice discounting you keep control of your own debtors. The best solution for you will depend on the quality of your relationships with your customers and the ability of your business to assign experienced professionals to deal with credit control.