When applying for a loan, do you
know what qualification factors
financial institutions use to determine if you are qualified?
“By knowing what lenders are looking
for during the approval process of a loan,
a business owner can better prepare and
address some of the issues prior to asking
for the loan,” says Frank Muniz, vice president and commercial relationship officer
of Banco Popular. “Commercial loans are
unique in that no two are identical. As
long as the risks can be mitigated, lenders
have more flexibility in getting the deals
Smart Business spoke with Muniz
about the five Cs of credit, how they are
weighed in the credit process and how
that can affect business owners.
What are the five Cs of credit?
- Character Before a business loan is
obtained, lenders need to be sure that they
can believe in the character of the business
owner(s) and business. The basis in measuring character is the business owner’s
credit reports, past payment trends, references, educational background and business experience.
- Capacity/cash flow There must be
adequate cash flow available to repay the
loan. A prospective lender will want to
know exactly how you intend to repay the
loan. The lender will consider the cash
flow from the business, the timing of the
repayment and the probability of successful repayment of the loan.
- Collateral These are the assets that
the borrower offers to the lender to secure
a loan. The primary collateral is usually the
business assets, but if they are not sufficient, additional collateral, such as real
estate, may be required.
- Capital The money you personally
have invested in the business. This is an
indication of how much you have at risk.
Lenders will expect you to have contributed from your own assets and have
taken personal financial risk before providing additional funds.
- Condition Refers to the outside factors that will be considered, such as the
local economic climate and conditions, both within your industry and in other
industries, that could affect your business.
Are all these points weighed equally, or are
there certain points that are more important
Capacity/cash flow and character weigh
more heavily than the others. The ability
for a business to repay the debt is evidenced by the company’s cash flow.
Lenders will typically require a debt service
coverage ratio of at least 1.2x. That basically means that the company’s cash flow
needs to cover debt obligations by 120 percent. Banks are not in the business of having to liquidate collateral in order to be
repaid, thus, no matter what the collateral
is worth, if the repayment ability cannot be
documented, the loan will not be made.
How can a company show that it has good
One way to determine good character is
through the credit ratings of the business
owner(s). A lender will typically require
the personal guarantee of any business owner who has a 20 percent or greater
stake in the company and will normally
investigate the personal background, credit history and personal references of this
individual. Past payment trends and references, especially if the references are made
by existing customers who are already well
regarded by the bank, are excellent measures of character. A Dun & Bradstreet
report can also provide insight into a company’s payment trends.
I recommend that business owners apply
for credit with their bank first. Their
banker should have a better understanding
of their business and banking needs as
compared to a banker with no previous
history or knowledge of the business.
What are the different types of loans businesses typically utilize, and how are they
Most common types of conventional
commercial loans are asset-based lines of
credit, commercial real estate loans
[investment and owner-occupied] and
Lines of credit are used to finance short-term working capital needs, such as the
acquisition of inventory/raw materials and
financing of accounts receivable. It is very
important that they revolve properly.
Banks want to make sure that the borrower is using the funds to acquire assets that
will be quickly converted to cash and that
the cash is then used to repay a portion of
the credit line. This is heavily weighed
when it comes time for renewal of the line
of credit, which is usually on an annual
For investment commercial property, the
primary source of repayment is usually the
rental income from the property. For
owner-occupied properties, the primary
source of repayment is the cash flow from
Equipment loans are usually for a short
term and are structured in accordance
with the useful life of the equipment.
FRANK MUNIZ is vice president and commercial relationship officer of Banco Popular. Reach him at (305) 938-0143 or