The 5 Cs of Credit: Capacity

This week we continue to examine the Five Cs of Credit and how lenders will assess your 504 loan application. The Five Cs are Character, Capacity, Capital, Conditions and Collateral. We previously discussed the quality of character and today we will discuss capacity and why it matters in the lending process.

Whereas character is scrutinized to determine a borrower's willingness to repay a loan, a capacity determination represents a borrower's ability to repay the loan. Intending to repay a loan is irrelevant if there is insufficient cash flow to make timely payments.

Capacity is assessed in many different ways. Lenders want to see all aspects of your financials to determine current and projected cash flows, as well as debt and liquidity ratios and credit history. These are all used to examine the feasibility of how you plan to repay the loan. To simplify: capacity is determined by deducting total cash outflows from your total income during a specific period. Your business needs to show a sustainable positive cash flow, meaning your income exceeds your expenses.

To ensure a healthy cash flow, a business must have liquidity. Liquidity is also defined as working capital. This is the difference between your current assets and your current liabilities. Your business needs the ability to generate cash to meet its ongoing commitments and expenses.

Lenders also look at current operating costs when determining cash flow. A monthly operating budget helps demonstrate what is feasible for your loan repayment schedule. However, your cash flow must meet a ratio above the proposed debt repayment in case is an unforeseen decline in income.

A lender will look at your business plan to assess whether your business can generate sufficient revenues to pay back the loan. We have a good summary of creating a business plan and what that entails. It should include a market analysis that describes your knowledge and experience in your industry, and explain the economics of the market, including its current size and projected growth. This provides the lender with information to validate your expected income.

Your business plan should also include information on company management. It is important to explain the experience and qualifications of the people that make decisions for your company. This proves to the lender that you have the personnel to operate successfully and generate revenue to repay the loan.

Along with the other qualities of credit, capacity is critical to the decision to lend. Community Business Finance will help you identify the information needed to prove your business has the capacity for a 504 loan. Our loan officers are efficient in gathering the right information, so it makes sense to bring us in early in the loan process. We make sure the loan is structured to SBA standards from the beginning. We will be examining the other Cs of Credit in the future, so check back.

Contact Community Business Finance today and discover how partnering with us can get your business the financing it needs with an SBA 504 loan.

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