Understanding your business's creditworthiness

Understanding your business’s creditworthi= ness

By Dale Windsor, Coffman Capital Inc.<= /p>

= Is it possible to understand the likelihood of your business getting a loan? The answer is yes. The key is to examine all the information your lender wi= ll have access to before you apply for the loan. Having a fundamental understa= nding of what information your lender needs—along with how it will be reviewed—will help you during the lending process.

Remember the lend= er will look at key indicators of your individual and business financial responsibi= lity in previous lending situations for repayment of the loan.

The four Cs of credit

The main question= the lender has when considering your loan application is your business’s ability to repay the loan. To make this judgment, lenders typically examine four areas of a business’s history and financial condition. These are called the four Cs of credit, and they have both subjective and objective components: capita= l, capacity, character, and condition.=

Capital

Capital is the ov= erall financial strength of your company based on sales and asset utilization. Capital answers the question: “What collateral can be used to back up this loan?”

Lenders will revi= ew your personal and business credit reports, as well as your business’s bala= nce sheets, to determine your capital. In addition to examining how you manage credit relationships and the value of your assets, lenders typically calcul= ate key financial ratios for your business and compare them to the ratios of ot= her companies of similar size in similar industries. This gives the lender a relative comparison of your business’s financial stability.

= Key ratios for judging capital

1. Current ratio =3D current assets / current liabilities. This rat= io indicates the surplus of cash (or near‑cash assets) on hand compared = with current short‑term bills.

Ratios close to 2= .0 are considered good. Ratios approaching 1.0 may indicate a warning to the lender that your company may not be able to pay unexpected expenses or carry new d= ebt.

2. Accounts receivable turnover ratio =3D net cr= edit sales / average accounts receivable for the year. This ratio indicates how = well your company is managing collections. Ratios higher than the industry avera= ge are better. They indicate your company is utilizing your accounts receivable assets effectively.

Capacity

Capacity is the a= bility of a company to meet current financial obligations, including current loans= and relationships with suppliers. Lenders examine your cash flow and earnings, along with your personal and business credit reports, to determine your capacity.

= Key ratios for judging capacity

1. Debt‑to&= #8209;equity ratio =3D (total debt + preferred stock) / total owner’s equity. This= ratio measures the amount of debt your company has compared to what has been inve= sted in the company. The debt shou= ld include the new loan being applied for. Your equity indicates any invested capital and earnings retained (not distributed) in the business.

Generally, a debt= ‑to‑equity ratio of 1.0 or greater indicates your company has maximized your borrowing capacity. Anything less than 1.0 can help justify obtaining additional loan= s.

2. Gross profit t= o net sales ratio =3D gross profit / net sales.&= nbsp; This ratio, a measure of profitability, shows how much of your business’s sales dollar is left after you pay for your cost of goods sold. Net margins for doctors after G&A are typically over 45%.<= /font>

3. Net income to owner’s equity ratio =3D net income / average owner’s equity

This ratio is oft= en referred to as the return on equity. It indicates how much of the ownerR= 17;s investment (equity) is needed to generate the business’s current leve= l of earnings.

Character

Character is an examination of the owner/manager’s experience, business skills and personal and business credit history. Here the lender is determining the company or owner’s likelihood of keeping financial promises. When deciding whether to extend credit, all lenders make a judgment about your character, capacity and collateral. Many use risk scores to automate their decision making. A score is a snapshot of your credit risk picture at a par= ticular point in time.

Credit bureau sco= res are calculated by computer software containing a scoring model. Each model is b= uilt by analyzing the information contained in large samples of anonymous borrowers’ credit files. Analysts tracked how those borrowers paid th= eir bills and identified patterns in the credit bureau data that correlated to = late payment.

Credit bureau scores are based on five main cate= gories of credit information. These are, in order from most to least important:

<= font size=3D3 face=3D"Times New Roman">1.Late Payments, D= elinquencies, Bankruptcies

2.Outstanding Debt=

3.Length Of Credit History

4.New Applications= For Credit (Inquiries)

5.Types of Credit = in Use

Past Payment Performance. The fewer= late payments, the better the score. However, if there are late payments, those that are most recent are more indicative of future default than those that occurred in the past. Naturally, having no late payments is best.

Credit Use.= People who are heavily extended tend to be higher risks than those who use credit conservatively. For example, someone using 75% of his or her availab= le credit represents greater risk than someone who is using only 25%.

Credit History. The longer someone has had credit established, the better. For example, a borrower who has had credit for less than two years represents a relatively higher risk than someone who has had credit for five years or more. What carries the most weight is how people p= ay their bills and how extended they are on their available credit.

Condition

Condition represents all the external factors—including the economy, the industry and government regulatory changes—that could impact your company.

What is a good score to get?

A “goodR= 21; score is a number that matches the level of risk a lender is willing to acc= ept for a particular loan. = The higher the risk, the higher the interest rate charged by the lender. For example, a Beacon score higher than 700 and a Bankruptcy less than 550 is considered “A” credit. It’s hard to say what’s a good score to get — it varies from lender to lender.

There are three m= ain credit bureaus in the U.S. Each may have slightly different information in = your file, so be sure to request a copy of your credit report from each. Careful= ly review the report to verify that all of the information is correct. If you = find any mistakes, report them to the bureau immediately. By law, the bureau must respond to your inquiry within 30 days.

You can reach the bureau at the following phone numbers:

EQUIFAX: (800) 685-1111
EXPERIAN: (800) 422-4879
TRANS UNION: (800) 888-4213