Understanding The 5 C’s of Credit and Why Are Important

Many traditional lenders evaluate the potential of small business owners using a framework called the five C’s of credit. It is important to have a good understanding of what lenders are looking for in order to have to best chances of getting approved for business financing.

What Are the 5 C’s of Credit?

Character, capacity, capital, conditions, and collateral are the five C’s of credit. Each lender is different, some lenders will use this system when underwriting an application and others keep them in the back of their mind. They also could be weighted differently depending on the lender. 

The 5 C’s of credit are used for small business financing mortgages, car loans, student loans, and more. As a borrower, if you know what the five C’s of credit are, the more likely you will get the loan you applied for.


Character measures how reliable and trustworthy you are. Lenders have a good reason to consider your character and that is simply that they need to be able to know if you are going to pay them back. To determine a person’s character lenders, look at the following:

• Work experience (to confirm consistent income)
• References
• Past interactions with lenders
• Credit history

Your credit history will let lenders view your credit report and credit score for information. This information lets them know how long you have been in business, bankruptcies, whether you make timely payments or not, and more. Credit scores range from 300-850, the higher your score the better chances you have of getting approval. Lenders rely on credit scores for setting the rates and terms of loans.
To improve your character, you can raise your credit score. Do this before you apply for loans to increase your chances of getting approved. Also, understand your credit report. If there are any issues or errors on your report, make sure to get it fixed as soon as possible.


Capacity is also referred to as cash flow and indicates your ability to repay the loan. When looking at an application, lenders look at the following factors:

• Business debt
• Cash flow statements
• Credit score
• Bank statements
• Repayment history of previous loans

When you apply for a loan, lenders will ask you to provide cash flow statements and bank statements. Others will look at your debt service coverage ratio (DSCR) and debt-to-income ratios (DTI). These ratios help determine your cash flow and how healthy your business is. A DSCR of 1.25 or higher and a DTI ratio of 36% or lower is what lenders look.

To improve your capacity, pay down past debt. This will increase that amount of cash flow available for a new loan. When you have less debt and more cash flow, lenders will feel more confident in approving you for a business loan.


Capital measures your dedication to your business and how much of your own money you have invested in. Banks typically provide a loan to owners who have invested their own money. This makes a statement saying that the owner believes in the business.
To improve your capital, fund at least 20 percent of the start up costs for your business with your own savings. Make sure to keep records of any investments made so you can show future lenders.


Conditions refer to the state of your business and correlates to that intended use of funds, so be sure to be explicit and transparent about your plan on using the money. Lenders may look at the following when assessing an application:

• How the money will be used
• Current economic conditions
• Current trends and future projections for the industry you are in

This information matters because it helps the lender determine how risky it will be for them to invest in your company. To improve conditions, start with having a plan. Know exactly what you are going to do with loan with a detailed business plan. Examples of what could included is that you want the funds for purchasing inventory, upgrading equipment, hiring new employees, and expanding your business. Also, improve your DSCR by increasing your net operating income, decreasing your net operating expenses, and paying off any existing debt.


Collateral is the assets you pledge to support your loan. Examples of these assets include inventory, equipment, accounts receivable or real estate. Collateral serves as a backup in the case the borrower fails to pay back the loan.
To improve collateral, consider knowing what collateral you have to offer. Evaluate the value of the assets you are willing to put up as collateral. Also be sure to be comfortable securing a loan with a blanket lien or a personal guarantee.