More than three years ago I wrote an article on how to prepare for a growing economy. Not all of my strategic visions come true, but this prediction has become a reality. Currently, GDP is growing faster than expected, unemployment is at an all-time low, and consumer sentiment has returned to high levels. All indications are that this growth economy is going to continue.
As I said in my last article, it is important for businesses to prepare for the liquidity and financing requirements that will be necessary to support and grow the business. One of the key sources to success is having access to bank credit. A working capital line of credit, equipment financing, and commercial real estate loans are important tools to have available when the need arises. You can best prepare yourself by knowing how your bank will consider and evaluate your request for credit. Although not all inclusive, banks continue to measure your financial stability using the tried and true “three C’s of Credit” which are capacity, capital and collateral.
Capacity –This represents your company’s ability to service the debt that it incurs. This is measured by using debt service coverage ratios that compare your cash flow to your debt service requirements. Your bank will need your financial statements, tax returns, and personal financial statements to fully analyze your capacity. It is important that they are up to date, accurate, and readily available.
Capital – This is the net worth or equity of your company. It consists of your investment in your company that supports the obligations of the company. It represents your company’s ability to absorb difficult times.
Collateral – Collateral represents a secondary source of repayment and are the assets that you can pledge to support your debt obligations. With a working capital line of credit, for example, accounts receivable and inventory are typically pledged. These assets should exceed the amount of the loan. With equipment loans and real estate, those related assets are pledged to support the loan. The bank will use these assets to repay the loan in the event you are unable to pay.
It can be complicated to evaluate a client’s financial strength, but if you are able to demonstrate your capacity, capital and collateral, you will have made a good start in obtaining the credit you need.
One final thing to keep in mind, in the financial services business a fourth “C” is considerably important – character. This is a critical component of the bank’s evaluation. How have you handled your business? Do you honor your obligations? These demonstrations of character are an important component of your bank’s review.
Univest Bank and Trust Co. is Member FDIC, Preferred SBA and Equal Opportunity Lender.