Five characteristics of the borrower, attempting to gauge the

chance of defaults.
The five Cs of credit are:
-Character
-Capacity
-Capital
-Collateral
-Conditions

Integrity
sufficient cash flow to service the obligation
net worth
assets to secure the debt
of the borrower and the overall economy

This method of evaluating a borrower

qualitative and quantitative measures.

incorporates

both

CHARCTER
What is the character of the management of the company? What
is management's reputation in the industry and the community?
Investors want to put their money with those who have flawless
credentials and references. The way you treat your employees
and customers, the way you take responsibility, your timeliness in
fulfilling your obligations these are all part of the character
question.
CAPACITY
What is your company's borrowing history and track record of
repayment? How much debt can your company handle? Will you
be able to honor the obligation and repay the debt? There are
numerous financial benchmarks, such as debt and liquidity ratios,

that investors evaluate before advancing funds. Become familiar

with the expected pattern in your industry. Some industries can
take a higher debt load; others may operate with less liquidity.

Capital
How well-capitalized is your company? How much money have
you invested in the business? Investors often want to see that
you have a financial commitment and that you have put yourself
at risk in the company. Both your company's financial statements
and your personal credit are keys to the capital question. If the
company is operating with a negative net worth, for example, will
you be prepared to add more of your own money? How far will
your personal resources support both you and the business as it
is growing? If the company has not yet made profits, this may be
offset by an excellent customer list and payment history. All of
these issues intertwine, and you want to ensure that the bank
perceives the business as solid.

Conditions
What are the current economic conditions and how does your
company fit in? If your business is sensitive to economic
downturns, for example, the bank wants a comfort level that
you're managing productivity and expenses. What are the trends
for your industry, and how does your company fit within them?
Are there any economic or political hot potatoes that could
negatively impact the growth of your business?

Collateral
While cash flow will nearly always be the primary source of
repayment of a loan, bankers look at what they call the
secondary source of repayment. Collateral represents assets that
the company pledges as an alternate repayment source for the
loan. Most collateral is in the form of hard assets, such as real
estate and office or manufacturing equipment. Alternatively, your
accounts receivable and inventory can be pledged as collateral.
The collateral issue is a bigger challenge for service businesses,
as they have fewer hard assets to pledge. Until your business is
proven, you're nearly always going to pledge collateral. If it
doesn't come from your business, the bank will look to your
personal assets. This clearly has its risks you don't want to be
in a situation where you can lose your house because a business
loan has turned sour. If you want to be borrowing from banks or
other lenders, you need to think long and hard about how you'll
handle this collateral question.

Asset Conversion Cycle Calculations

The Asset Conversion Cycle (ACC) calculations portray the
number of days a business takes to purchase raw materials,
convert those materials into finished goods and services, sell
them, and receive payment. The ACC has three parts:
1. Accounts Receivable Turnover Days
2. Inventory Turnover Days
3. Payables Turnover Days
The word formula looks like this: Accounts Receivable Turnover
Days + Inventory Turnover Days - Accounts Payable Days.

The calculations for each are as follows.

Accounts Receivable Turnover Days: This calculation represents
the number of days from the sales of goods and services to
payment: (Accounts Receivable / Sales X 365).
Example: US$ 2000,000 Million in annual sales and $200,000 in
accounts receivables at the end of the year equals a 36.5 Account
Receivable Turnover days.
Inventory Turnover:
This calculation measures the time between the purchase of raw
materials and the sales of products produced from those
materials: (Inventory / Cost of Goods Sold (COGS) X 365).
Example: COGS is $1.2 Million with a year-end inventory of
$164,000 equaling an Inventory turnover days of 50. ($164,000 /
$1,200,000 X 365) = 50 days.

Payables Turnover:
This formula calculates in days the average length of time
between the purchase of goods and services and the payment of
them. (Accounts Payable / COGS x 365).
Example: $182,400 is the accounts payable balance and again
the COGS of $1.2 million resulting in an accounts payable days of
55.5. ($182,400 / $1,200,000 X 365) = 55.5 days.
Asset Conversion Cycle Result:
The ACC result frame above calculations would look like this:
Accounts Receivable Turnover Days (36.5) plus the Inventory
Turnover Days (50) minus the Payables Turnover (55.5). The ACC
result is 31 days.
Rice Hedging

The 5 C's of Business Credit

Lending institutions want to lend money because it's the way they make money. However, they only want to
lend money to a borrower who is able to repay the loan on time and in full.
When lending financing over a certain limit to small businesses, lenders customarily analyze the worthiness of
the borrower by using the Five C's: capacity, capital collateral, conditions, and character. Each of these criteria
helps the lender to determine the overall risk of the loan. While each of the C's is evaluated, none of them on
their own will prevent or ensure access to financing. There is no automatic formula or guaranteed percentages
that are used with the Five C's. They are only a variety of factors that lenders evaluate to determine how much
of a risk the potential borrower is for the financial institution.
Note: When lending small amounts of money under $50,000 (small is a relative term to each lender) typically
eligibility depends solely on personal and business credit scores. A credit analysis is not usually performed.
Depending on the personal and business credit scores, they either will or will not approve the loan.

Understanding Credit Analysis

To determine if you will be able to establish business credit, consider each of the following C's to see how you
would look to a potential lender:

Capacity This is an evaluation of your ability to repay the loan. The financial institution wants to know

how you will repay the funds before it will approve your loan. Capacity is evaluated by several components,
including the following:
Cash Flow refers to the income a business generates versus the expenses it takes to run the

business analyzed over a specific time period. For example, if a company regularly generates $10,000
a month of revenue, and it has expenses of $8,000 a month, the lender would determine that there is
$2,000 a month in cash flow that could be used to repay the loan. If a company has the same amount
of expenses as income, that would mean the cash flow would be zero, and the lender would have
reason to be concerned about how the company plans to repay the debt.
Payment history refers to the timeliness of the payments that have been made on previous

loans. In the past, it was more difficult for commercial institutions to determine whether a small
company had a good payment history. However, today there are companies that evaluate commercial
credit ratings (such as Dun & Bradstreet) that are able to provide this kind of history to lenders.
Contingent sources for repayment are additional sources of income that can be used to repay

a loan. These could include personal assets, savings or checking accounts, and other resources that
might be used.
Ultimately, capacity is the main requirement for lending and business credit. The ability to receive regular
payments generated by a company's cash flow is the easiest way a financial institution can be repaid.

Capital Typically, a company's owner must have his own funds invested and at risk in the company
before a financial institution will be willing to risk their own investment. Capital is an owner's personal
investment in his business which could be lost if the business is a failure. There is no fixed dollar amount or
percentage that the owner must be vested in his own company before he is eligible for a business loan.
However, most lenders want to see at least 25% of a company's funding coming from the owner before
they will step up.

Collateral Heavy machinery, stocks and bonds, and other expensive business assets that can be
sold if a borrower fails to repay the loan are considered collateral. Since small items such as computers
and office furniture are not typically considered collateral, in the case of most small business loans, the
owner's personal assets (such as his home or automobile) are required in order for the loan to be
approved. When an owner of a small business uses his personal assets as a guarantee on a business
loan, that means that the lender can sell those personal items to satisfy any outstanding amount that is not
repaid.

Conditions This is an overall evaluation of the conditions surrounding the loan including general
economic climate at the time the loan is requested and the general purpose of the loan. Economic
conditions specific to the industry of the business applying for the loan as well as the overall state of the
country's economy also factor heavily into a decision to approve a loan. Clearly, if a company is in a
thriving industry during a time of solid economic growth, there is more of a change that the loan will be
granted than if the industry is declining and the economy is uncertain. The purpose of the loan is also an
important factor. If a company plans to invest the loan into the business by acquiring assets or improving its
equity, there is more of a chance of approval than if it plans to use the funds for more risky expenses such
as expanding into new markets. Most financial institutions require that the borrowed funds are used solely
to increase income or decrease expenses.

Character This is a highly subjective evaluation of a business owner's personal history. Lenders have
to believe that a business owner is a reliable individual who can be depended on to repay the loan.
Background characteristics such as personal credit history, education, and work experience are all factors
in this business credit analysis.

Note: When applying for a small business loan, don't forget the importance of personal relationships. Apply for
a loan at a bank where you already have a positive business relationship. Also, make an attempt to meet with
the person who will be evaluating your application, such as a bank's lending officer, rather than the teller who
handles your day-to-day banking transactions.

Did you ever hear about the 5 C's of lending? Most lenders use these five factors when
considering a loan:
1. Character- An evaluation of your financial performance and management; your credit
score.
2. Capital- This is your financial position; assets, liabilities, net worth and equity.
3. Capacity- Your ability to repay the loan, your debt ratio.
4. Collateral- This is what you offer the lender for security should you default or cannot
repay the loan.
5. Conditions- These are things a lender may want of you to assure or encourage
repayment of the loan.

Work on improving your weak C's so that you can improve your chances of getting what you
want. Knowing what a lender expects before applying can only help your chances of getting
the loan.