Banks, in general, have done a poor job of informing businesses what it takes to get a bank loan approved. In the bankers’ world, many of the most important considerations are what we refer to as the Five C’s of Credit:

Capacity: History of positive cash flows

The best predictor of a business’s likelihood of repaying a bank loan as planned is a proven history of positive cash flows. This cash flow history needs to be adequate to make loan payments on the new bank loan request, plus a little. Banks desire a debt service coverage ratio  of approximately 1.30 multiplied by the debt service. Notice that I said a history of positive cash flows. Because startup businesses don’t have a “history” of operations, it is very difficult, on their own merits, for them to obtain almost any type of bank financing.

Collateral: Adequate collateral support

In the event that future cash flows are not sufficient to make scheduled bank loan payments, banks want some other business asset or assets to serve as a back-up source to satisfy bank loan payment obligations. Collateral can take many forms but often will include accounts receivable, inventory, real estate and equipment, as well as other assets. When calculating acceptable collateral, banks will want the value of the collateral to be greater than the amount of the principal amount of a  bank loan. Whenever a bank attempts to liquidate collateral, they rarely are able to realize fair market values for the asset being sold. Therefore, the collateral value needs to be one-third to one-and-one-half times greater than the loan amount.

Capital: Adequate capital to support normal business operations

Although a business starts out with a vision in a person’s mind, it rarely makes it to the next stage without capital to help make this vision a reality. Capital, in this sense, is the amount of personal source funds and prior earnings retained by a business. The far-and-away No. 1 reason loans are turned down by banks is that a business does not have sufficient capital. It’s not unusual for business commentators, and occasionally politicians, to suggest that a business obtain capital from its bank. This is poor advice. Banks provide loans to businesses long after the business owners find or earn capital to support formation and operation of the business. Typically, banks will require a business to show something in the range of 30 percent capital divided by the equity as a percentage of total assets.

Conditions: Conditions affecting the business

Many internal, as well as external, conditions have an impact on a business. Although a business owner may have little or no control over these conditions, it is critical that the business owner be aware of them. Additionally, the business owner needs to have a strategy and plan for managing the impact of these conditions on business operations. External conditions include governmental regulations, business climate and competition, while internal conditions include staffing, management, operational issues and many others. The business owners’s grip on understanding conditions and demonstrating the ability to deal with them is critical to the bank.

Character: Borrowers, owners and management need to conduct themselves in business and personally in good character

A good reputation as a business and as a person is one of our most important assets. Bankers care about how business is conducted and how individuals conduct themselves. Indications of good character are an important component in the loan approval process. In addition to community and personal opinions, credit history is an important indicator of whether or not a bank can rely on a party to honor their obligations to the bank.

In the end, it’s pretty simple: Banks lend money to organizations and people who show the greatest likelihood of repaying them. The above factors are not all inclusive in helping a bank make the correct decision to approve a bank loan, but they are certainly some of the most important.

For more information about bank loan approval, call (602) 445-6531 or visit