The 5 Cs of Credit Can Help Arizona Businesses Make Their Bank Loan Application Shine

July 26, 2022

As a business owner, you’re constantly looking at the future — and sometimes, the forecast calls for an injection of financing to keep your company moving forward. Whether you need to fund a new commercial space, an equipment purchase or increasing liquidity, a business loan can be part of the solution. 

The good news is that financing is out there — but some Arizona businesses aren’t taking advantage of it. According to the SBA, only about half of small businesses survive five years or more. To land on the winning side, funding may play a significant part in the race for survival. 

Researching the funding that might be available to you is a crucial first step. Options to consider may include a Small Business Administration (SBA loan), conventional loan, equipment financing or a loan against assets, like inventory or accounts receivable. 

Businesses like yours are finding funding. In fiscal 2021, two SBA lending programs — SBA 504 loans and SBA 7(a) loans — made more than 61,000 loans totaling $44.8 billion to small businesses nationwide. In the Phoenix-Mesa-Chandler metropolitan statistical area (MSA), banks issued $6.26 billion in small business loans during 2020, according to Community Reinvestment Act reports. 

As you navigate the process of obtaining financing, your banker can be a strong resource. It’s good to bear in mind how banks mitigate lending risk by a thorough evaluation of borrowers’ credit. Based on factors that include what’s known as the Five Cs of Credit, this evaluation helps a lender determine the likelihood that a borrower might default on a debt. Here’s what you need to know about the Five Cs before you begin your loan application.

Securing a loan with underlying assets mitigates risk for the lender. In general, banks have greater opportunity for loan applications that list collateral than for those without it. Not only does the presence of collateral tell a bank that your business has a solid foundation, but the lender can claim the asset in the event of borrower default. Equipment, inventory or accounts receivable can serve as collateral to secure a loan.

Do you maintain a healthy cash reserve? Lenders will look at your company’s balance sheet and consider how much the business owner has invested in the company. A borrower with skin in the game has a strong incentive not to default on a loan. In the event that revenue won’t cover the debt, capital can be a way to keep making regular payments.

It’s a good idea to know your debt-to-income (DTI) ratio and apply for only the credit you need. Banks may be prohibited from issuing loans to borrowers with a DTI of 43% or higher. In assessing your ability to repay the loan, the bank may review your company’s cash-flow statements to determine income from operations. Bankers may also analyze the amount of debt outstanding compared to the revenue a business expects to generate each month.

Lenders examine the pattern of how business owners use credit to determine character and reliability. Do you make payments on time? Do you keep your credit utilization low? Is there a bankruptcy in your history? A strong credit history can make you a better candidate for a loan.  

Part of this assessment may include a review of your personal credit score. If you know your score could use some polishing, it’s smart to focus on raising your score before applying for a business loan.

Banks make decisions against the backdrop of current economic conditions, and they generally look at the broader circumstances surrounding your business and the loan. This can include interest rates, loan terms and the strength or weakness of the overall economy. Bankers also take into consideration the reason a borrower wants the loan, whether for working capital, equipment or expansion.

Whatever your goals for your business, a loan can help you make them a reality. Your expert banker is a trusted business adviser, just like your accountant or attorney, who can discuss your options and opportunities. To learn more about how we can assist you with credit decisions, contact your Alliance Bank of Arizona relationship manager.