The 3 Cs of Commercial Credit

The 3 Cs – character, collateral, capacity – summarize the elements that a financier uses to underwrite a loan. This technique of assessing the client comprises both qualitative and quantitative measures.

Character

Character refers to the borrower’s reputation. The shareholders who will guarantee the loan and the management of the business will all be scrutinized to determine whether they are reliable and will repay the funds.

The lender will usually look at the business owner's credit history to gauge honesty and reliability. Considerations may include:

• Whether or not they pay bills on time.
• Whether or not they’ve used credit before.
• How long they’ve been in business, and what positions they held before starting the business.
• How long they’ve lived at their respective addresses.

Lenders will also look at the credit scores of the business owners. This score is numeric, typically between 300 and 850, gleaned from the information in your credit report. High scorers generally have lower risk. Each lender has its own standards, but many of them use credit scores to assist them in making their evaluations. It all depends on the level of risk they find suitable for a particular credit product.

Credit scores are weighted as follows: 35 percent payment history, 30 percent amount owed, 15 percent length of credit history, 10 percent new credit, and 10 percent types of credit in use.?

Collateral

Collateral is any asset used to secure the loan. Savings, real estate, inventory, accounts receivable, and equipment can be used as collateral.

The lender asks for collateral because it can be sold or collected to generate funds to pay the loan in the event of insolvency. Since in the experience of most lenders asset classes such as prepaid amounts, goodwill, and investments will not raise any significant amounts, they are generally not considered for collateral.

If you’re using a property as collateral, your future lender will consider its location, quality, and adaptability.

Capacity

Most commercial credit officers refer to capacity as cash flow, which represents the company's ability to repay debt. Since a big down payment will reduce the risk of default, the lender will consider any capital the borrower puts into a potential investment. In short, the lender looks at how much debt the borrower can handle. The following are usually requested from the borrower for the lender to evaluate cash flow/debt service:

• Business tax returns
• Historical financials, such as the balance sheet and profit & loss statements, interim financials, and/or projections
• Personal financial statements for each guarantor
• Rent rolls for leased property

If you’re considering a business loan, understanding the 3 C’s will give you a high-level understanding of what a potential lender will look for.

Information provided on this blog is for educational purposes only and is not intended to be business, legal, tax, or accounting advice. The views and opinions expressed in this blog are those of the authors and do not necessarily reflect the official policy or position of Lendio. While Lendio strives to keep its content up-to-date, it is only accurate as of the date posted. Offers or trends may expire or may no longer be relevant.