What Are the 5 C's of Credit Analysis for Equipment Financing?

If you need equipment financing, there are several factors that lenders evaluate during the equipment financing application process. Credit worthiness criteria can be categorized into two verticals — the 5 C's of credit analysis and the 5 C's of documentation.

These are five of the factors equipment financing lenders typically use to evaluate the risk associated with lending you money.

1. Capacity

Capacity refers to your ability to afford monthly payments and repay loans on time. 

The lender will determine if you can make payments when they are due using the debt-to-income (DTI ratio), which is represented with a percentage.

Follow the steps below to calculate your business's DTI ratio:

• Add up your monthly debt payments
• Divide your monthly debt payment by your monthly income before taxes 
• Multiply that number by 100

Lower DTI ratios typically indicate lower monetary risks and lenders can use this number to signify whether or not your business can take on more debt.

Before getting started, have a plan for how you'll make the monthly payments. Consider the following:

• Cash flow 
• Payment history
• Current market share

For Cat Financial, we also want to know if the equipment your interested is in acquiring is replacing an existing unit or if you’re planning to expand your equipment fleet.

2. Capital 

Your business's capital encompasses all financials that can be utilize to repay your loan, including:

• Balance Sheet
• Net Worth
• Capitalization 

Put simply, Assets – Debts = Net Worth or Capital.

How much money do you already have invested in the business? Your company's debt-to-equity ratio — your company's liabilities divided by shareholder equity — will be a determining factor in whether or not your business has enough equity to shoulder more debt.

Capital represents the avenues you can take to make payments on your loan if something were to happen to your business like losing a critical client or other major financial setbacks. Capital is similar to a down payment as it can show you are a capable and serious candidate for financing options or business credit.

Ultimately, your capital provides lenders with peace of mind, thanks to the added security it offers. 

3. Collateral

Collateral refers to something you can offer as security for a line of credit or loan. If you are unable to make your payments, the lender can take your collateral as a means of repaying your debts.

The lender will evaluate the asset you are offering. If you secure other debt with that same item, remember you will have to subtract that value.

Banks and other institutions that extend credit offer secured and unsecured options. Secured loans or lines of credit indicate that the recipient has to offer collateral. This trade is considered to be less risky for lenders. If you do not pay back your debts, these items are at risk and you may forfeit them. 

What additional monetary or capital-based guarantees can you put forward? Although many lenders require collateral for obtaining business financing, obtaining leasing equipment or a commercial line of credit often does not involve this factor.

5. CHARACTER 

Character encompasses your business's credit history. The lender will look into how you've managed your past debts.

Different lenders have various criteria for analyzing your credit scores and reports. They want to see how much money you've borrowed in the past and your payment history details.

A record of the following could negatively impact your business's ability to get a loan or line of credit:

• Bankruptcies 
• Late payments
• Foreclosures

What kind of general impression do you make on the lender? Although this component can be tough to quantify, business experience, educational background and personal credit score all serve as factors that help lenders make an informed decision.

You will also need to provide the proper documents during the credit analysis process. Lenders will review your firm's financial history to determine your company's financial strength and ability to repay any credit that has been extended. 

Some lenders establish minimum credit score requirements. The higher your business's score, the lower the associated risks of loaning you money or equipment.

If you need to repair your business credit score, consider doing the following:

• Pay bills on time or early 
• Establish repayment agreements 
• Lower your credit utilization ratio
• Actively dispute any errors in your credit report