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The Five Cs of Credit

Capacity to repay, capital, collateral, conditions, and character, are referred to as the "Five Cs of Credit".

Learning Objective

  • Name the Five Cs of credit


Key Points

    • Capacity to repay, the most critical of the five factors, indicates to the prospective lender exactly how an individual intends to repay a 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.
    • Capital is the value of assets that a debtor currently holds. Potential lenders may expect an individual to communicate their current assets so as to indicate their ability to pay back a loan.
    • Collateral is additional form of security you can provide the lender. Giving a lender collateral means that you pledge an asset you own, such as your home, to the lender with the agreement that it will be the repayment source in case you can't repay the loan.
    • Conditions focus on the intended purpose of the loan. Will the money be used for working capital, additional equipment, or inventory? The lender also will consider the local economic climate and conditions both within your industry and in other industries that could affect your business.
    • Character is the general impression you make on the potential lender or investor. The lender will form a subjective opinion as to whether or not you are sufficiently trustworthy to repay the loan or generate a return on funds invested in your company.

Terms

  • collateral

    A security or guarantee (usually an asset) pledged for the repayment of a loan if one cannot procure enough funds to repay. (Originally supplied as "accompanying" security. )

  • capital

    Money and wealth. The means to acquire goods and services, especially in a non-barter system.

  • loan

    A sum of money or other valuables or consideration that an individual, group, or other legal entity borrows from another individual, group, or legal entity (the latter often being a financial institution) with the condition that it be returned or repaid at a later date (sometimes with interest).


Example

    • How might a potential lender use information about a debtor's capital? For example, a business owner's capital would be how much they have personally invested in the business and is an indication of how much you have at risk should the business fail. Prospective lenders and investors will expect you to have contributed from your own assets and to have undertaken personal financial risk to establish the business before asking them to commit any funding.

Full Text

The Five Cs of Credit

Capacity to repay is the most critical of the five factors. The prospective lender will want to know exactly how an individual intends to repay a 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. Payment history on existing credit relationships—personal or commercial—is considered an indicator of future payment performance. Prospective lenders also will want to know about your contingent sources of repayment. Other relevant information includes already existing debts that a debtor may hold.

Capital is the value of assets that a debtor currently holds. A business owner's capital, for instance, would be how much they have personally invested in the business and is an indication of how much you have at risk should the business fail. Prospective lenders and investors will expect you to have contributed from your own assets and to have undertaken personal financial risk to establish the business before asking them to commit any funding .

Capital

Capital is the value of assets that a debtor currently holds.

Collateral, or guarantees, are additional forms of security that you can provide the lender. Giving a lender collateral means that you pledge an asset you own, such as your home, to the lender with the agreement that it will become the repayment source if you can't repay the loan. A guarantee, on the other hand, is just that: someone else signs a guarantee document promising to repay the loan if you can't. Some lenders may require such a guarantee in addition to collateral as security for a loan.

Conditions focus on the intended purpose of the loan. Will the money be used for working capital, additional equipment, or inventory? The lender also will consider the local economic climate and conditions both within your industry and in other industries that could affect your business.

Character is the general impression you make on the potential lender or investor. The lender will form a subjective opinion as to whether or not you are sufficiently trustworthy to repay the loan or generate a return on funds invested in your company. Your employment background and experience in business and in your industry will be reviewed. The quality of your references and the background and experience levels of your employees also will be taken into consideration. A person who seems to have a stable background, indicated by steady employment and housing, is more likely to seem trustworthy to lenders.

An additional, often cited "C" of credit, is credit history, which looks at the debtor's past uses of credit. Evidence of responsible use and repayment of credit is a good sign to lenders.

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