Worried about a cash flow crunch? Working capital is the lifeblood of any small business. While banking lending rates are improving, they still remain below pre-recession levels. That’s bad news for small businesses facing a cash flow problem. Poor cash management is a contributing cause in 82 percent of small business failures. A lack of working capital not only keeps you from paying suppliers and employees, but may also keep you from pursuing expansion opportunities at the appropriate time.
When a cash flow crunch strikes, a small business loan can be a true lifeline. Loans help you bridge a cash flow gap so your business can continue to make payroll, pay your suppliers on time, make equipment upgrades, and cover unexpected expansion costs. But small business loans are also difficult to qualify for. In fact, a recent Babson report (sponsored by Goldman Sachs) reviewed 10,000 small businesses and found that ‘access to capital’ was one of the four major hang-ups for small businesses in 2016.
Without a clear understanding of financial management basics, you could come up short just when you need cash the most. Your solution: master the ins and outs of financial management before you need a small business loan. Then, when the time comes to apply for a loan, you’ll be good to go.
First, Learn the 5 C’s of Credit
The Kabbage-curated financial management resource list and the SBA’s Financial Management education curriculum are great places to begin learning financial management basics. In this article, we want to initiate the learning process with an introduction to the 5 C’s of Credit. The 5 C’s of Credit: Character, Capacity, Capital, Collateral and Conditions, are root concepts in credit decision making. By understanding these basic concepts, you will form the building blocks for deeper financial management understanding and you will be able to speak the language of your lender, an important way to establish confidence, trust and relationship.
1. Credit history: A credit history is a macro assessment of your likeliness to repay a borrowed sum based on your previous track record of repayment. Different types of lenders base their credit decisions on different criteria depending on their internal metrics and risk comfortability. In addition to written results on a credit report, some lenders will use or require a credit score. Different agencies use different methods of determining this score, but it is similarly based on your credit reports. Credit reports and your credit score provide a quick indicator of your riskiness.
Related: What Affects Your Credit Score?
2. Capacity: While credit history and score play a significant role in a lending decision, your capacity to repay a new potential loan is also a major consideration. Income stability and before tax debt-to-income ratio (DTI) are additional considerations here.
3. Collateral (when applying for secured loans): Lenders generally feel more comfortable lending money if a borrower can provide two different sources of payment. Capacity will be a major consideration, but a secondary source of repayment is generally known as collateral. A loan is known as “secured” if collateral is required upfront to guarantee repayment. Collateral is essentially a pledge of something you own (e.g., a house or car) that can be used to repay the loan if your primary repayment source fails. Collateral evaluation generally tests hard tangible assets, but new financial products are coming online which offer collateral ‘credit’ for intangible assets such as patents, trademarks, copyrights, licenses, etc.
4. Capital: While income should be the primary source of repayment, and collateral can provide comfort as a secondary source or repayment, lenders feel most comfortable lending to borrowers with a demonstrated record of smart capital management.
5. Conditions: How will you use the money? Will you be buying hard assets such as property or equipment that could be sold if the business fails? Or, will the capital go into paying exorbitant executive salaries? Lenders want to feel secure in loan repayment and may offer a loan with conditions attached. These conditions are meant to manage expectations (and mitigate potentially bad management decisions) and generally aim to build confidence in loan repayment.
Related: How Canadian Credit Scoring Works
Online Small Business Loans versus Bank Loans
Traditionally, small businesses have been forced to rely on credit from commercial banks and governments. Today however, technology has brought dependable small business lending into the online marketplace. New credit metrics and big data analysis tools not only offer credit access from a wider universe of providers, but also offer lines of credit based on previously underutilized business metrics.
In addition to capital and credit access, online lending speeds the credit process along. Going into a bank or applying for government loan assistance can be extremely tedious and time-consuming. Online commercial lending services however employ technologies which help lenders arrive at credit decisions more quickly than their brick-and-mortar counterparts. Online business loans provide unparalleled service in this regard, providing instant approval with no fees or obligations.
Next Steps: Securing Capital for Your Business
The ins and outs of financial management may not be the most exciting aspect of running a business, but a robust understanding of these financial basics is absolutely essential to ensuring business growth. Building a solid understanding of financial management terminology and concepts will instill confidence in your discussions with lenders and provide you the greatest chance to qualify for a line of credit. Preparation is absolutely essential. From business plans to income statements to repayment schedules, getting your ducks in a row streamlines the loan application process. Remember: the better you can explain your story to a lender and the more information you organize on paper, then the more likely you and the lender are to arrive at a positive outcome – a small business loan to support your business’s growth.