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Mastering the 5 C's of Credit

By Colton Thompson| Published December 8, 2023

Mobile phone with credit score on it

Creditworthiness to Finance Your Business Dreams

Are you wondering if you are eligible for a business loan or worried about applying for one? Confused about what lenders consider when reviewing a business application or how to get a business loan? Here at First Community Bank Utah, we understand that the act of getting a business loan can be overwhelming and can feel like an intricate labyrinth, especially when it comes to understanding what determines your creditworthiness. From ambitious startups to well-established corporations, securing the right financing is crucial to fuel your business dreams.

In the world of credit, the five Cs - Capacity, Capital, Collateral, Conditions, and Character - are common indicators used by lenders to analyze potential borrowers and their creditworthiness. Mastering these five components can help pave the way towards your business obtaining the financing solutions it may need. Now, let's look over each of the Cs in detail.

Capacity: Demonstrating Your Ability to Repay
Capacity refers to the borrower’s ability to repay a loan. Lenders do this by assessing the borrower’s income against their recurring debts. There are many ways to measure this, with the majority of lenders using the debt-to-income (DTI) ratio for consumer loan products and debt service coverage ratios (DSCR) for commercial loan products. Maintaining a low DTI ratio, or a high DSCR, now and in the future, is essential in obtaining financing, as it portrays stability and assures lenders of your ability to manage the loan's payments effectively. Here at First Community Bank Utah, we are a cash flow lender, and this is one of the most crucial factors when assessing our business loan applications. 

Capital: An Indicator of Financial Health
Capital, in the 5 Cs of credit, refers to the money you personally have invested in the business, the money you have retained in the business, or the money that you can invest into the business. Essentially liquidity and net worth. One reason lenders consider this is due to the logic that if you have invested a large amount of your money into a business, you are more likely to do everything in your power to make that business succeed. Another reason lenders look at this, is to assess how long your cash reserves can float business debts if your business hits hard waters, or what cushion is available if hard assets are to be sold to make ends meet. Having strong capital reserves and strong cash equity, reassures creditors that you're committed and less likely to default on loan repayments.

Collateral: Securing Your Loan
Collateral represents the assets you're willing to pledge and secure the loan. These could be physical assets like real estate, equipment, or inventory; or these assets could be stocks & bonds, certificates of deposits and savings accounts, future cash flow, receivables, or the cash value of a life insurance policy. It is important to note that every lender has different collateral guidelines. Collateral provides a safety net for lenders, as they can fall back on these assets in the event of a loan default, reducing their risk.

Conditions: The Influence of External Factors
Conditions are the external circumstances, or factors, that could affect your repayment ability. This could include industry trends, the current state of the economy, or specific regulations that may impact your business. Lenders consider these conditions to understand the risk associated with the loan within the larger context of the market. Demonstrating your understanding of these conditions, and how to respond, can have an influence on your financing request because it reflects the borrower’s wherewithal and flexibility to manage outside influences.

Character: Your Financial History and Reputation
Character is a subjective measure of your trustworthiness, based on your history of meeting financial obligations. A common measurement is a FICO score, which is determined by factors such as credit history, payment punctuality, and any existing debts. Want to know more about credit scores? Check out Jason Robinson’s article Dissecting your Credit Score, because a good credit score and clean financial history can significantly enhance your chances of securing a loan. Have a bad credit score? Check out Breann Garfield’s article Building or Repairing Your Credit Score.

Understanding how lenders assess risk is essential for businesses looking to secure financing, and the 5 Cs serve as the framework used by lenders to evaluate potential borrowers. By mastering the 5 Cs, you can significantly improve your creditworthiness and take a giant leap towards realizing your business dreams. Remember, securing the right financing isn't just about having a great business idea; it's about demonstrating to lenders that you have the capacity, capital, collateral, character, and understanding of conditions to ensure its success.

Here at First Community Bank Utah, it is our vision that everyone comes in as a customer and leaves as a friend. We strive to earn your trust and friendship by having your back, living by our words, and always doing what is right. If you are still wondering if you are eligible for a business loan or concerned about applying for one, please reach out to one of our branches to go over your dreams with one our amazing loan officers. It is our purpose, and our pleasure, to build our communities one dream at a time.

Colton ThompsonAuthor: Colton Thompson, Commercial Loan Underwriter