OnPath Credit Union

The 5 Cs of Business Lending: What Are They and Why Do They Matter?

The “five Cs” of business lending refers to a commonly applied rubric lenders use to assess risk when evaluating the creditworthiness of potentially borrowers seeking business loans. They are:

  1. Character
  2. Capacity
  3. Capital
  4. Collateral
  5. Conditions

While not every lender has a formalized checklist listing each of these criteria, the five Cs is a convenient shorthand for the general measures that are applied in nearly every business loan approval decision.

The ultimate goal for any lender, whether they’re offering business loans or personal loans, is to be repaid with interest. All their analysis will be geared toward determining the likelihood of repayment. The riskier a borrower is for the lender, the higher the interest they will likely charge. From the borrower’s perspective, having good marks on all five of the Cs is the best way to secure a great rate and good terms on a loan.

Character

Should your personal character matter when banks judge your creditworthiness? That’s a complicated question – who you are as a person might not have anything to do with your business. Plenty of good people have run into difficulties in their businesses. For good or ill, how a person or business conducts itself is a variable that impacts perceived risk.

Character in the context of the five Cs comes down to reputation, trustworthiness and personal integrity. Lenders evaluate the borrower's credit history, employment background and overall reliability and past behavior to determine the likelihood they will repay the loan. How they make these determinations can be complicated, especially if the information is hard to come by. One of the benefits of establishing a long-term relationship with a Federal Credit Union is the two-way street of familiarity. You get to know the bank and it gets to know you.

You can technically establish a reputation with any banking institution, but when you work with a large, nationwide bank, the relationship is inevitably impersonal and distant. Their determination of who you are as a businessperson will be based solely on things like whether you were ever late on credit card payments or overdrafted a checking account.

At OnPath Federal Credit Union, you have the opportunity to personally know the decision makers. We’re active members of the New Orleans community and are committed to making determinations based on more than just entries on a spreadsheet.

Capacity

This is a measure of a potential borrower’s ability to repay the loan based on their financial resources and income-generating capabilities. Capacity determinations are based on things like a business's debt-to-income ratio and cash flow. Those types of financial indicators can help a bank or credit union determine whether a business has sufficient means to cover the loan payments and their other financial obligations.

Capital

This deceptively simple measure of creditworthiness basically boils down to net worth. However, the capital factor can also encompass a business owner’s willingness to invest in their own business, which can be a telling measure of their seriousness and faith in the business’s ongoing stability. Lenders typically prefer borrowers who contribute a significant amount of their own capital to their business, as it demonstrates commitment. The more committed the borrower is to their business, the less likely they’ll be to risk it all by defaulting on their loan.

Collateral

This is the tangible or intangible asset that the borrower pledges as security for the loan. In case of default, the lender can seize the collateral to recover the outstanding loan balance. Examples of collateral include real estate, equipment, inventory or accounts receivable. Lenders evaluate the quality, value and liquidity of the collateral to ensure it can cover the loan amount.

Not all collateral is made equal, and a loan applicant’s collateral can serve as an indicator of their business’s financial strength and commitment to the loan. Diversified collateral may be viewed as less risky than a single illiquid piece of property that might lose value over the course of the loan.

Collateral that’s liquid or can be easily made into cash (and has stable valuation) may significantly reduce the perceived risk on the lender’s end.

Conditions

This refers to the external factors that can impact the borrower's ability to repay the loan, such as market conditions, industry trends and economic indicators. Lenders consider these factors to assess the risk associated with the loan, taking into account how changes in the business environment could affect the borrower's financial stability and profitability.

Unfortunately, there’s not much most business owners can do about this measure. Businesses in New Orleans, Louisiana and the rest of the country are subject to all kinds of trends that are beyond their control. Whether now is a good time or a bad time for businesses like yours may affect decisions about your creditworthiness.  

Learn About Your Business Loan Options in New Orleans

Do you want to expand your business or just need some extra capital for equipment replacement, inventory or some other vital upcoming business expense? The business banking team at OnPath Federal Credit Union are here to help. Every business client is more than just a name on our ledger. We treat you like a person and make decisions locally for the benefit of our members and community.

Call us at 800.749.6193 for more information.