5 Questions A Bank Asks Before Making a Commercial Loan

Acronyms make anything much easier to remember. In this case, you only need to remember 5 C’s.

Matt Murphy at The Strategic CFO has today’s great post, The 5 C’s of Credit, which will help private business owners understand how banks and other lenders decide whether or not to make a loan to your company.

The article is instructional for all forms of commercial loans, including loans for business owners who might be securing a loan in the context of a leveraged buyout or other leveraged private equity transaction.

Matt goes into excellent detail on each of the 5 C’s in his post, but here is an abridged summary of the 5 C’s:

Cash Flow – A lender must know how much cash your business generates that is available after all company expenses to pay back the loan’s interest and loan principal?

Collateral – In the event that the cash flow of the firm becomes impaired, the lender wants to evaluate the “hard assets” of the firm. That way, if the cash flow is insufficient, the lender can take possession of the assets to get paid back.

Capital – Banks and other lenders want to see how much equity capitalis in the business. If the owners don’t have a lot of their own “skin in the game”, then they might be less inclined to stick with the company in tough times, which leaves the bank holding the keys without any capable management in place.

Conditions – Lenders want to analyze whether or not the surrounding environment is attractive to the business. Is the company in a growing market? Are their customers healthy and do their customers pay on time? If a lender is evaluating a loan to an auto parts supplier, they have to take into consideration that the American auto manufacturers are in terrible condition how that might affect an auto supplier. These conditions can very meaningfully impact the price of capital

Character – Lenders want to make sure they are lending to firms and management teams with sound ethics. While this may be the toughest C to analyze, it can easily be the most important, especially when a company hits a difficult patch.