If you are a business owner and have applied for a loan, you have likely been asked by your lender to submit business financial information and personal financial information. The business financial information can come in the form of prior year tax returns and business financial statements prepared by the accountant. Personal financial information can be personal tax returns and a personal financial statement. The personal financial statement will ask about the individual’s assets and any liabilities or debts that they may have. Also, the personal financial statement may ask questions about prior financial history (i.e. bankruptcies, collections, etc.) or estate information on the individual. So what does all this mean and why are these items required as part of a business loan application? The items are needed because a lender will typically apply what is known as the 5 C’s of Credit in the review of the loan application. This will aid the commercial lender in making an educated decision to approve a loan request or not. Furthermore, they can dictate specific loan rates and terms. Let’s take a closer look at each of the C’s used as criteria in the review of a loan application.    

The Character of the individual behind the business can be partially determined by a simple credit report obtained by the lender. This will show a payment history (good or bad) the lender can use to project future payment patterns. The data is often presented in the form of a credit score. Not only are payment patterns analyzed, but also credit usage over time (i.e. credit card balances, etc.). The higher the credit score, the stronger the individual behind the loan and that’s always a good thing.

The next “C” stands for Capacity. This is a deep dive into determining the income earned by the business or individual and the outstanding debts. A commercial lender will want to see a stable stream of annual net income along with a reasonable amount of debt outstanding. From a business perspective, the commercial lender will want to see a debt coverage ratio of at least 1.25x, which means cash flow to service debt (annual net income + depreciation expense + interest expense) should be at least 1.25x total annual debt service. The annual debt service is all the business’s monthly loan payments multiplied by 12. The individual’s capacity is referred to as the debt-to-income ratio (DTI). The DTI ratio is calculated by adding an individual’s total monthly debt payments and dividing that by his or her gross monthly income. The lower the DTI ratio, the stronger the individual’s capacity. 

Sufficient liquid assets or Capital is the next “C” on our list. A business must have sufficient capital, or cash on hand, to invest in new equipment as needed or to maintain operations. A bank can certainly help when additional capital is needed, such as a working capital line of credit, but having a consistent level of capital to support operations is vital.  

Collateral is commonplace in the commercial lending arena no matter the business. A bank will want collateral on virtually all of the loans extended. Depending on the purpose of the loan funds and what they are used to purchase, collateral could be real estate, business equipment or business assets (i.e. accounts receivable, etc.). Should a loan go into default, the bank will take action to repossess the collateral in order to repay the loan. To further protect the bank, a discount is often taken against the value of the collateral to allow a margin should the collateral value diminish.    

Most loan commitments have Conditions, which account for the last “C”. This category can be quite expansive and may include the current interest rate environment or economic conditions, market activity in a particular industry or bank policy restrictions. This is definitely a discussion a business owner will want to have with the commercial lender. So there you have it…the 5 C’s of Credit you should know!

First Community Bank and Trust plays a vital role in the community as a long-term provider of financial services. We would like to have the opportunity to help you today. Call John Lockie, Senior Vice President - Commercial Lending at (708) 946-2246 to discuss your commercial loan needs. He can set up an appointment to meet with you at your place of business or our Beecher or Peotone Financial Centers. We appreciate your business and would like to be part of your Resource Team. Reach out to us today – we’re here to help. You won’t regret it!

About First Community Bank and Trust
First Community Bank and Trust is a privately-owned bank. Established in 1916 First Community Bank and Trust has been serving Beecher, IL, Peotone, IL and the surrounding communities for over 109 years. Our commitment to providing the best banking products and services is matched only by our outstanding customer service. We offer traditional community banking services, including mortgage, consumer, and commercial lending, as well as state of the art electronic banking services.

Press Contact:
Steve Koehn, Senior Vice President
First Community Bank and Trust
(708) 946-2246

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