Business loan

The 5 Cs to consider when applying for a business loan

Opinions expressed by Entrepreneur the contributors are theirs.

For some entrepreneurs, starting your business is not an option. This is where the search for an alternative method of obtaining capital comes in. Business credit is the best-known option for an entrepreneur to receive an influx of capital.

Business credit is the ability of a business to borrow money to buy something now and pay the money back later. When a business is applying for credit, there are five things (the five Cs) that a lender will consider before approving the business for a loan. Here they are below:

1. Character

The character refers to your company’s credit history. Depending on your business history, your personal credit history may also come into play. credit history (eg, credit cards, lines of credit, auto loans), the borrower is likely to be approved for the loan. If the character of the borrower displays an immature credit profile (eg no previous credit loans, arrears, collections), the lender is likely to reject the borrower.

Similar to personal credit, there are ways to check your business credit profile, such as and (Dun and Bradstreet). Business credit profiles are not as mature as personal credit, so you may see discrepancies in your different report source profiles.

Related: 5 Tips for Getting the Business Credit You Need to Start and Scale Your Business

2. Capacity

The capacity of a business is the ability to repay a loan. A lender will look at your debt-to-income ratio (DTI) to calculate capacity. The formula to calculate your debt to income ratio is (total debt to total income) x 100.

The lower your DTI, the better your ability to repay a loan in the eyes of a lender. As with personal credit, you want to keep your business DTI at 36% or lower to be considered for future loan opportunities.

3. Capital

Capital is the asset of your business that the borrower can use to repay a loan. Only liquid assets – such as funds in bank accounts, investments and assets that the lender can claim – are taken into account. Accounts receivable are not capital in this case because they are not tangible.

Related: How to qualify for a business start-up loan

4. Warranty

Collateral is an asset that can be offered as collateral to reduce the risk of capital loss if the lender defaults. Examples of collateral would be property, cash, inventory, accounts receivable, or equipment.

Typically, lenders lend 80% of the value of the collateral. This means that the borrower should have 20% of the purchase amount or some other way to raise the capital. This is called a loan-to-value ratio.

5. Terms

Terms include how the company plans to use the money and external factors, such as the state of the economy. For example, an equipment loan may be less risky for a dropshipping business than a working capital loan in a risky business environment, such as a loan company.

When applying for credit, some of the five Cs are more within the company’s control than others. Let’s discuss how to increase your chances of being approved for credit by improving character, ability, capital, collateral, and terms.

Related: These Things Can Make You Successful in Borrowing Business Loans

How to Increase Your Chances of Being Approved for Credit

  • Character Enhancement: Character is absolutely on the business to maintain. Some ways to improve your character rating include early or on-time payment of bills that are reported to credit bureaus (e.g. credit cards and lines of credit), higher credit age, diversification of your credit portfolio with a combination of revolving and installment credit and have adverse events (such as late payments) removed or closed. By calling the number provided, you can verify that your lenders relate to the credit bureaus. Some lenders, mostly 30-90 year old net providers, may not report until you ask.

  • Capacity improvement: The company must earn more money or incur less expense to improve its capacity. Another option is to have a co-signer with a low DTI to improve your DTI.

  • Capital improvement: Capital is more difficult for the company to control if the company is struggling to generate income. It is recommended that the company start saving as much as possible when preparing a loan application to ensure that the debt-to-income ratio will be 36% or less. Some lenders provide credit at a higher interest rate, up to 50% DTI.

  • Improved guarantees: Collateral is more difficult for businesses to control, primarily digital businesses, as collateral in most cases must be liquid and wholly owned. One way to improve the strength of collateral is to enter into a secured loan agreement by raising additional assets equal to or greater than the loan amount.

  • Improved conditions: The terms are generally beyond the control of the lender and the borrower. The borrower must have a solid reason for applying for the loan and a credit profile strong enough to meet the lender’s lending criteria. This helps the company to have financial documents in order and a solid outlook on revenue generation.

There are many considerations when applying for a business loan. Building relationships with lenders helps increase the chances of being approved for a loan. Still, the most important attributes to consider are DTI, reason for loan, and business outlook. You should consult your financial advisor or accountant before applying for a loan.