Banks and other equipment financing lenders use the Five Cs to decide whether or not to give a loan: Character, Credit, Cash Flow, Capacity, and Collateral. But banks look at small and medium-sized businesses from the point of view of a Fortune 500 company, while equipment financing companies look at applicants from the point of view of a small business. This brings up the sixth C: common sense.
When a lending institution talks about the Five Cs, they mean the following:
Character - Every lender wants to know what kind of borrower an applicant will be so they can make safe, smart decisions about whether or not to give credit. The longer a business has been in business, the more its payment history and outstanding credit show how the management feels about debt and making payments on time. Even though public records and references can be helpful, the best way to judge a small business is by its owners. How they handle their own financial obligations is usually a good sign of how likely they are to make payments on time. The more closely held a company is, the more attention is paid to the credit history and business history of the people in charge. No matter how good a business plan looks or how reliable the owners of a company have been in the past, a realistic lender will also want personal guarantees from the owners of the business. This could be a signature or a promise of cash or something else as collateral.
Credit: Business credit reports give you a quick look at how likely a company is to pay its bills on time, as well as any bad public records, like lawsuits, liens, or judgments, that hurt a company's credit rating. Also shown on these reports are any UCC filings. Possible equipment lenders want to know how much a business has borrowed in the past. The longer a business has been in operation, the easier it is for a lender to figure out how good its credit is. A good ten- or twenty-year credit history is obviously very important. This is bad for a new business that is less than two years old. So, when traditional data sources like Dun & Bradstreet and Paynet can't give enough information, the owners' personal credit histories become very important.
Cash Flow: Lenders want to see that a business that wants a loan makes enough money to pay its employees, cover its fixed operating costs, and make on-time payments on a loan or lease for new equipment. There are many ways to define cash flow, but most lenders figure out the cash flow that can be used to pay off new debt by adding the net profit to non-cash costs like amortisation and depreciation.
Capacity is kind of like the depth chart for a football team. A company that wants to get money also needs to be able to handle bad times. Capacity takes into account the fact that sometimes unexpected things happen, like when a key employee gets sick and can't work, or when a big customer leaves, or when the economy goes down and demand for products or services drops by a lot. A company's cash flow can also be hurt by a number of other unlikely but possible problems. And these problems can be short-term or long-term. So, capacity is a measure of a company's ability to pay back a loan or lease on equipment with cash on hand or to quickly turn real estate, stocks, or other assets into enough cash to pay off debt.
Collateral: A business needs more than just the equipment being financed as collateral to get a loan or lease. How much more collateral is needed depends on the type of lender and the status of the business. A traditional bank usually wants a blanket lien on all of a business's assets, but an equipment finance company usually only uses the equipment as collateral. Some lenders also offer sale-leasebacks and refinancing for equipment debt that has already been taken out. This lets a business free up cash flow or lower their monthly payment by getting a loan or lease for the equipment.
Common Sense: Every purchase decision and every loan decision must be based on common sense. A lender needs to know how adding more equipment will help the company grow and stay stable. Even though every lender takes a risk and every company takes a chance when it buys new equipment, both the lender and the borrower should use common sense when deciding whether or not to finance the equipment.
