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Will you get the bank financing your company needs? Usually, credit approval is based on the Five C’s – capacity, capital, character, conditions and collateral – the factors banks and other sources of financing have used for many decades to help determine whether a business is a good risk.
When you apply for a business loan, the lender will generally ask for financial statements for the current year-to-date and last three to five years, a projection or budget for the next year or two, identification of any unusual items (expenses, loss of revenue or capital expenditures) over the last few years, the structure of your current debt and reasons for getting new debt, and other data on your company. Your lender then analyzes the data by looking at the Five C’s.
A lender wants above all to know: Will your business be able to generate enough cash on an ongoing basis to repay the amount borrowed? Analysis of your company’s financial statements and projections will provide the answer. A cash-flow statement gives information about the sources and uses of cash over the reporting period, and can be helpful in judging whether enough cash is likely to be available for the loan payments. If cash-flow statements are not available, then the lender will look at free cash flow, which is the net income of the business adjusted for noncash items like depreciation. The lender will also evaluate other capacity factors, such as your sales forecasts and the average number of days your company takes to collect revenue after a sale.
A lender will analyze your financial statements to assess working capital, net worth, existing debt, accounts receivable and other indications of the overall financial strength of your business. All are important factors in determining your ability to carry new debt.
Your reasons for borrowing are also a factor in the credit decision. A lender needs to understand the purpose of your loan. You may have to provide a written business plan documenting your business strategy and how you intend to use the borrowed funds.
No lender ignores the general reputation of a business and its managers. Your company’s stability, the number of years it has been in business, and its structure and financial history, as well as its managers’ personal standing within the business community, will always affect credit decisions.
Before approving a loan, a lender also looks at the external market conditions under which you operate. These might include the national and local economy, your industry and the geographic markets where you do business, as well as your competition and any known or likely changes in taxes and regulations.
To reduce their risk, lenders seek to obtain a security interest in their borrowers’ assets. As a condition of approving your loan, you’ll most likely be required to pledge certain company assets, such as equipment or real estate, at least to the extent of your intended indebtedness.
If you’re planning to seek bank financing for your business, Doeren Mayhew can help you understand the loan underwriting process and put together the financial information you’ll need, while providing input into the types of financing that would be appropriate in your specific situation. For more information, contact our team of advisors today.
This publication is distributed for informational purposes only, with the understanding that Doeren Mayhew is not rendering legal, accounting, or other professional opinions on specific facts for matters, and, accordingly, assumes no liability whatsoever in connection with its use. Should the reader have any questions regarding any of the news articles, it is recommended that a Doeren Mayhew representative be contacted.
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