What Elements Decide the Creditworthiness of a Business Owner?
Most businesses usually operate on credit lines. If not credit, many business owners resort to loans and investment plans to conduct needed business expansions or pull the company out of debt. However, lenders must consider a lot of things to approve business loans.
One of the essential things for lenders, be it an independent investor or a bank, to consider is the creditworthiness of the business owner applying for the loan. Creditworthiness refers to the overall financial standing, history, collateral, and liquid value of the individual or business owner applying for a loan.
Several factors determine the creditworthiness of an individual. While there are no internationally or legally set standards for assessing the creditworthiness of an individual, banks and investors resort to the 5Cs of credit analysis to gauge whether a business is worth taking the risk or not.
The 5Cs include:
Here is a brief overview of these five elements which decide the creditworthiness of a business owner.
- Cash flow situation: The Capacity accounts for the cash flow statements of the business. For an investor to approve loans, there must be cash-flow statements from the past and present and those based on future projections.
These cash flow statements provide a clear insight into the business performance in recent history, areas of strength and weaknesses,
and the potential for growth in the coming years. Investors and lenders usually require a cash-flow projection of at least three years to lend money to the business.
It is imperative to have updated financial statements, including cash flow, income, and balance sheets, to convince lenders
of your business’ capacity.
- Total invested business capital: This accounts for the total amount of personal investment, earnings retained, and any other controlled assets under the business owner’s name.
The capital is primarily viewed
as an alternate source of making money, either by liquidating these assets if necessary or using them as guarantees. Usually, banks measure the capital as a percentage of the total investment cost. It is more of the lender’s security:
the higher the capital, the higher the chances for banks to sanction the loan.
- Economic conditions and loan settlement points: These refer to the requirements of the loan itself. They account for economic fluctuation, changes in currency rates, deflation and inflation, and any other factors contributing to the loan deal’s monetary aspects.
In addition to these economically dependent conditions, lenders consider interest rates, repayment schedules, and span, as well as principal amounts. Once the loan is approved, the requirements are made a formal
part of the agreement.
- Business owner’s history and history of previous repayments: This accounts for the borrower’s previous credit history and record with loans, debts, and payments.
The character reflects the borrower’s reputation in financial dealings and speaks for reliability
and honesty. This assessment can be both qualitative and quantitative. In terms of quantitative measures, the character can conveniently be judged by the repayment schedule as promised in previous credit records
and credit history score through third-party analysis. Qualitatively, this includes the borrower’s connections and reputation among the business circles. Banks put a lot of weight on the previous credit history
If, by any chance, the borrower has filed for bankruptcy or was unable to make repayments
as per the schedule, he is less likely to get the loan sanctioned
from the bank.
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- Additional guarantees & collaterals include any personal warranties or assets nominated by the borrower in the deal. Deposits can consist of savings or any other investments for individuals. For businesses, collateral includes any equipment or assets owned within the business premises and any receivable payments in the business accounts. The ease of liquidation by banks usually measures collateral.
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