Before they provide you with a loan, your banker will assess if your company represents an acceptable risk for them and if it will be able to repay its loan.
This risk assessment will impact the interest rate you pay on a loan. It also determines:
- whether you get the loan
- what the lending terms and conditions will be
A banker will be comfortable lending money if your company’s assets and performance represent an acceptable level of risk.
Satisfy the 5 “Cs” of lending
1. Character
Does your management have the skills, experience, and track record to deliver?
The first thing a banker will be looking at is your character and previous business experience. The first impression counts a lot. From dress and attitude to the way you present your project, the banker will be trying to assess your ability to manage the business.
The banker also wants to see that you have built your plan based on a sound analysis that takes into account the market, the competition, and the economic context. Do your own research and show that you know the trends, the opportunities, and the risks.
This boosts your credibility. A simple, concise presentation of facts and figures will back up your statements and business plan.
2. Capacity
Do you have the ability to repay the loan? Banks will be looking at both your track record and your anticipated cash flow.
Your credit history will be one of the first things a banker looks at when evaluating your loan request. To get prepared, make sure you pay all your bills on time and don’t overuse your credit lines.
A willingness to put a significant amount of money into your business will also show your lender that you are committed to the project and willing to share the risk.
The banker will also need to know how you are going to use the money, The viability of your project will be assessed in terms of the strengths, the opportunities, and the risks presented in your business plan, including financial forecasts, the management team’s experience, and the marketing and sales strategy. You must convince the banker that your business can become viable and that you are ready to take it there.
3. Capital
While analyzing your present and past financial performance, your banker will evaluate your business’s:
- liquidity
- growth
- profitability and cash flow
Your banker will review liquidity indicators such as your current ratio, to evaluate your company’s ability to pay its current liabilities in a timely fashion.
He or she will also look at your year-over-year growth in terms of revenue, gross margin and net income. These are important indicators of your company’s current and future health.
Third, your banker will look at your ability to generate positive cash flow and income from operations, because this is where your loan payments to the bank will come from.
Profitability indicators such as gross margin and operating margin ratio are among a banker’s key measures to see if a loan will be repaid.
4. Conditions
Before providing you with a loan, your banker will determine terms and conditions that will keep their risk at an acceptable level through the repayment period.
Once the loan is approved, the bank will perform annual reviews to monitor the loan’s performance.
Should your loan performance or your company’s risk become unacceptable, your banker may request additional collateral security or demand complete repayment.
5. Collateral
While evaluating your loan request, the bank will review the assets you are willing to provide as collateral to secure the loan.
In the event you are not able to repay the loan, the bank would then take ownership of these assets to repay itself, for example, your company vehicle.
Often mistaken as the most important thing a banker wants, collateral is actually lower on a banker’s priority list, compared to the other “Cs.”
How a banker looks at your business
One thing to understand is that a banker will take an objective look at your business and his or her opinion might not jive with your vision.
Sometimes entrepreneurs think they should receive more money than the fundamentals of their business merit. They also often underestimate the riskiness of their project.
Don’t think of your banker only as a source of money, but also a a source of advice. A banker sees several business plans a week, so it is safe to say that he or she often has much more experience than the entrepreneur.
You can avoid a potential “no” by stepping back and by taking another look at your business.
