Business Credit Analysis
Small businesses require many different resources to successfully start and continue functioning for the first few years. One of the most important resources is capital, the funds the business uses to begin operations. Small businesses seek capital from several different sources, including friends and family and angel investors, but most businesses also end up applying for loans with local banks or other lenders. In this case, the lender must examine the business' credit.
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Business Credit
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Business credit is based mostly on how solvent the business is, and how easily it can make loan payments and produce the results that it promises. Many different factors play into a business credit analysis, and most primary financial documents are examined as a result. A business applying for a loan should make sure that it has all of these documents prepared and that its work is very accurate.
Lender Motives
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The lender is usually a local bank that has a policy of supporting small business projects, or a larger bank that requires a detailed financial study before agreeing to lend money to any business. They are the ones who conduct the credit analysis. In some ways this analysis resembles an individual's credit check, but the lender takes a much closer look at business records and how the company has performed and will perform in the future. They want to be sure they will receive their loan payments in the required time.
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The Five C's
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There are five C's that lenders examine when conducting a business credit analysis: capacity, capital, collateral, conditions, and character. Capacity explores how the business is going to repay the loan and how successful it has been in repaying loans in the past, while capital involves making sure that the business has enough funds to pay off the loan regardless. Collateral is the type of security the lender may require before making the loan, while conditions focus on what the loan will be used for and if its purpose will help grow the business. Character is a general quality concerning the impression the business gives the lender.
Important Documents
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The lender will look primarily at four different documents when conducting the loan analysis. The first is the personal financial statement, which indicates the net worth of all major holders of business equity. The second is the business balance sheet, which shows the state of the business at a particular point in recent time. A profit and loss statement will show the business' profits and losses throughout the last year, and a statement of cash flows examines how the business receives and spends cash as part of business operations.
Ratio Analysis
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The lender will also often conduct ratio analyses of the business to predict future income or ensure the business has enough value. There are many different ratios that can be used. Profitably, for instance, simply shows how much profit the business makes after all expenses, while leverage ratios measure how much the business is financed by debt versus how much it is financed by equity.
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References
- Photo Credit Small print through a blurry pair of glasses image by mashe from Fotolia.com
