The 4C's of Credit for Business
Credit people look carefully at trade accounts, especially in tough financial times, before they ship goods. What credit managers look for can be summarized in the following, termed the "4 C's of Credit":
Character refers to the financial history of the customer; that is, what kind of "financial citizen" is this person or business? Character is most often determined by looking at the credit history, particularly as it is stated in the credit score (FICO score). Factors that will affect your credit score include:
- Late payments
- Delinquent accounts
- Available credit
- Total debt
- The fewer the problems, the higher the credit score. A high personal credit score (over 700) may be the most important factor in getting a business loan.
Capacity refers to the ability of the business to generate revenues in order to pay back the invoice. Since a new business has no "track record" of profits, it is riskiest for a credit person to consider. If you are buying a business, capacity is easier to determine, and a business that can show a positive cash flow (where income exceeds expenses) for a sustained period of time has a good chance of getting an open account.
Capital refers to the capital assets of the business. Capital assets might include machinery and equipment for a manufacturing company, as well as product inventory, or store or restaurant fixtures. Creditors consider capital, but with some hesitation, because if the business folds, they are left with assets that have depreciated and they must find someplace to sell these assets, at liquidation value. You can see why, to a creditor, cash is the best asset.
Collateral is the cash and assets a business owner pledges to secure a credit limit. In addition to having good credit, a proven ability to make money, and business assets, credit people will often require an owner to pledge his or her own personal assets as security for the account. Some credit managers require collateral because they want the business owner to suffer if the business fails. If an owner didn't have to put up any personal assets, he or she might just walk away from the business failure and let the creditors take what it can from the assets. Having collateral at risk makes the business owner more likely to work to keep the business going, as creditors reason it.
In order to get a credit limit, a prospect customer will need to:
- Have an excellent credit rating
- Be able to prove the business will generate revenues to pay the invoices.
- Show that the business assets have value in case they need to be sold to pay off the account, and
Pledge personal assets in case the business fails.