Here’s what bankers want to see when you submit a loan request.
In a literal sense, every business is bankable—that is, they’re capable of becoming a bank’s customer. But most times when you hear that word, it refers to a company’s ability to win approval for its loan request. And that can be harder to define.
The key is to know what banks want to see from small businesses. The five C’s of credit serve as the basic model that most banks use: character, capacity, collateral, capital and conditions.
CHARACTER is difficult to articulate, because everyone has his or her own definition. Some banks may look at a credit score to determine one’s character, while others are looking at references. Get a clear understanding of how far the bank is looking into this one, as it may make sense to provide references up front if necessary.
CAPACITY means cash flow, or the ability to repay the loan. Business owners need to know their debt to income (DTI) ratio. Other key data to have on hand, include: fixed charge coverage ratio, cash flow coverage ratio, and EBITDA (earnings before interest, taxes, depreciation and amortization) to debt payments. Keep in mind that the banker will be operating under the general and logical premise that the business should be producing more than $1 in cash flow sufficient to service each dollar in debt. Most will want to see consistency for two to three years.
COLLATERAL is what banks fall back on when there are impairments to cash flow. But the reliance on collateral is where the debate comes into play. Some may wonder why the bank wants to see income for an extended period of time, if you have ample collateral. No question—collateral is a must, but the bank will have to take full responsibility for selling the collateral if the business gets into trouble and the bank has to take over. The bank will have to hire someone to sell it, which will take a cut into the sale, along with the stigma that goes with selling assets labeled “bank owned.” One generally has to have some form of collateral to be “bankable,” but if a business is losing money, the strength of collateral alone will not make it “bankable. ”
CAPITAL tends to cause the most confusion. The essential question is: What percentage of assets does the business actually own when the dust settles and all liabilities are paid off? It is not unusual to find a business or business owner who distributes all earnings from the company, leaving very little strength to the balance sheet. The bank does not want to be the only player with “skin in the game” and will want to know that the company is committed as well.
CONDITIONS refers to the economic climate. During the 2008 downturn, some business owners saw their covenants or loan terms change even when their companies were doing well. This was an outcome of the economic climate. In conversations about financing, business owners should know how their industry is performing as a whole, not just their company specifically. They should also be aware of the broader economy.
The five C’s are an excellent guide to learning how to be a “bankable” customer, and how business owners can lead a conversation with their banker about obtaining competitive financing. While it may seem daunting, don’t be afraid to start the process. The key is to be prepared and open to address any challenges up front to avoid unwelcome surprises along the way.
Dominic Karaba is executive vice president of business banking at UMB Bank. dominic.karaba@umb.com
