How do lenders evaluate a loan request?
Lenders typically use the ‘Five Cs of Credit’ to evaluate a loan request:
- Character: This refers to the applicant’s honesty, integrity and trustworthiness. Lenders review a business description, including the background and experience of key members of management.
- Capitalization: Here the lender attempts to determine the equity or capital structure of your company. Particular attention is paid to the capital initially injected into the company and the profits the company has retained. The lender relates this net worth figure to total indebtedness. This comparison is often referred to as your leverage position. To understand the capital structure of the company, the lender reviews your balance sheet, looking for asset composition and seeking hidden value therein.
- Cash flow: A lender analyzes cash flow for businesses to determine if the applicant has the ability to repay the debt. Historical (the past three to five years) and current cash flow is calculated. The applicant and the lender should determine any cost savings projected or increased revenues or expenses anticipated due to proposed expansion. These projections should be incorporated into a ‘pro-forma’ cash flow.
- Conditions: This refers to external factors in the economy and the borrower’s industry. Besides industry trends, the lender will want to understand: Who are the primary competitors and how do you compare? Is your industry expanding or contracting?
- Collateral: This provides another way out for the lender if the primary repayment source fails. Different lenders accept different types of collateral, but the most appropriate collateral is generally the asset being financed. If a long-term loan (more than one year) is requested, assets with a useful life of more than one year (e.g. machinery, equipment, real estate) should be taken as security. Likewise, loans for less than one year are normally secured by short-term collateral, like accounts receivable and inventory.
Any final thoughts to share with businesses looking to finance?
Be patient. Listen to your commercial banking officer and ask for tips on how to improve your chances for financing if your first attempt is not successful. The application process for financing requires an investment of time, energy and trust. Understanding and providing your commercial banking officer with the information he or she seeks to approve your financing request will help you and your business succeed.
Amanda Mahaney is senior vice president and group manager of Comerica Bank’s Small Business Banking Midway/Spring Valley location in Dallas. Comerica Bank is a commercial banking subsidiary of Comerica Incorporated (NYSE: CMA), the largest banking company headquartered in Texas. In addition to Dallas/Fort Worth, Comerica Bank locations in Texas can be found in Austin and Houston. To receive e-mail alerts of breaking Comerica news, go to www.comerica.com/newsalerts. Comerica Bank, Member FDIC
