Small and medium-sized businesses (SMBs) are the lifeblood of the Canadian economy. Although these organizations typically have less than 500 employees, together they become a mighty force, making up 99.8% of all Canadian businesses, accounting for approximately 52.5% of Canada’s GDP and employing nearly 90% of the population. To maintain their business edge, SMBs are often in search of the right capital to keep their operations running smoothly.
Business owners often search for external financing in the form of loans, mortgages and lines of credit from financial institutions. However, asking for commercial financing is very different from asking for a personal loan, due to the larger amount of risk involved with lending to a company.
At Assiniboine Credit Union (ACU), we work with many business owners and entrepreneurs to guide them through the process. Before submitting your financing application, there are certain things you should prepare in advance — and some important considerations so you aren’t surprised along the way.
The ‘5 Cs’ of Credit
Before ACU grants you a business loan, you’ll meet with a Business or Community Account Manager who will get to know you, learn about your business, and gather the required documents to process the application. The Account Manager will be looking to satisfy the ‘5 Cs’ of credit to assess if your business represents an acceptable level of risk.
This risk assessment will help determine whether the loan gets approved, the interest rate you will pay on the loan, and the overall terms and conditions of the financing. In addition, your business performance will factor into the funding approval decision, along with your business’ ability to provide adequate collateral.
The ‘5 Cs’ of credit is a set of criteria that a business must satisfy in order to qualify for a loan.
In the character assessment, the Account Manager will determine your ability to plan, control and organize the business. One of the first things an Account Manager will be looking at is your business acumen and experience.
In this step, first impressions matter. Make sure you are dressed for success and that you bring a positive and collaborative attitude. The Account Manager will be on the lookout for this information:
- Does the management team have the right skills and abilities to run the business?
- What experience and qualifications does management have?
- What is the track record of the business?
In addition, you should also have your business plan ready. Include details such as a market trend analysis, SWOT analysis (strengths, weaknesses, opportunities and threats), and how your business will operate given the realities of the current economic environment. It helps to do plenty of advance research on the factors that will have an external influence on your business, and to show you’ve prepared your business for future success.
This step is all about credibility. Having a plan with data to back it up will help you build trust with your Account Manager and improve your chances of approval.
Capacity is about demonstrating that the business will be able to make the payments on the loan. To do this, there will be a review of historical financial results including financial statements and projections.
You’ll need to prepare financial records, including financial statements, a pro-forma income statement and cash flow projections. Your personal credit history and net worth will also be reviewed to determine the creditworthiness of you as the owner. If you have all of this documentation ready to review, it will help advance the process.
Another way to demonstrate your commitment to the business is if you have a sizeable down payment for the project being financed. This shows that you are willing to share the risk.
Finally, in this category, your Account Manager will need to know the purpose and use of the funds requested. Project viability is determined based on the strengths, opportunities and risks that are found in your business plan. This includes the lender’s assessment of the viability of your financial forecasts, along with the strategies you will use to achieve both your sales and expense targets.
For existing businesses with more financial history, other factors will come into play, such as your year-over-year growth in terms of net revenue/sales, gross margin and net income. These are important indicators of your company’s current and future health. The loan proposal will speak to the project at hand and describe its impact on the business.
While analyzing your present and past financial performance, your Account Manager will evaluate your business growth, profitability and cash flow. They will also review your business’s liquidity (through analysis such as the current ratio) to evaluate your company’s ability to pay its liabilities in a timely manner. Profitability indicators such as gross profit margin and net income are among an Account Manager’s key measures to see if a loan will be repaid.
If you are starting a new business, then your business plan, financial projections and the strength of the individual guarantor’s personal covenant provide indicators of the company’s viability. Your Account Manager will then look at your ability to generate positive cash flow and income from operations, since this is where your loan payments to the credit union will come from.
In addition to all of these capital factors, net worth indicators such as the debt-to-equity ratio will be reviewed. This can inform the lender about the level of debt the business has relative to its capital base, no matter how long you’ve been in operation. If a business has too much debt, a new loan may not be approved.
As part of the loan approval, the Account Manager will determine the terms and conditions of financing that will keep the credit union’s risk at an acceptable level throughout repayment.
For all forms of commercial lending, a review of borrowing facilities occurs at least once per year. This helps to monitor the loan performance and will help determine if your company is adhering to both performance and financial agreements.
Understanding all the conditions of any financing is crucial, so make sure you’re aware of all the details at this stage — and what will be required of your business in the future. If the risk profile of your business increases over time, or some other unacceptable event occurs, the credit union may require you to pledge additional collateral — or the loan may be called and repayment demanded in full.
Business loans almost always require collateral such as commercial equipment, real estate, a company car or other valuable asset. The lender will inspect and substantiate the collateral you are willing to pledge to ensure it meets requirements.
However, not all collateral is acceptable for all types of lending. For example, commercial equipment is not accepted as collateral for a revolving line of credit. Your Account Manager can walk you through the types of collateral that can be accepted.
Keep in mind that the collateral can play a much more important role in the event of an unfortunate downturn in business. For example, if the business cannot repay the loan, the credit union would take ownership of the collateral in order to liquidate it and use those funds to reduce and/or pay off the debt.
The final decision
Throughout this process, Commercial Account Managers take an objective approach to reviewing and analyzing your business lending proposal. Despite best wishes, there are times when the needs of the business may not match what the credit union will be able to approve. Likewise, your business may be hoping to qualify for more financing than the performance of the company will allow. And in some cases, business owners can underestimate the riskiness of a new project, which can lead to financing letdowns.
It’s important to be prepared for these potential outcomes, and to have an open conversation with your Account Manager to discuss options for now, and how to improve your financial position even further to assist in future financing.
Our Business and Community Account Managers are a great source of help and advice with regards to planning for the financial needs of your business. ACU has been lending to SMBs for over 75 years and our Account Managers see several business plans each week, giving us tremendous experience to draw from when working with clients. We are always happy to work with your business to help you find the right financing options for continued success.
If you’re ready to take the next step in business financing, call us to set up an appointment with an ACU Business Account Manager today.