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June 1, 2010

February 22, 2010

The Five C’s of Lending

Filed under: Credit tips — Tags: , , , , , , , , , , , , — afp @ 6:11 pm
approved

There are Five C’s of Credit that all business owners should know when they are ready to request financing for their business.  Those Five C’s are:

Cash Flow
Collateral
Capital
Character
Conditions

Every business owner should know where they stand on all Five C’s and use them to help in the preparation of questions and concerns you may get on your business when you apply for your next equipment finance.

CASH FLOW

Does your business generate enough cash flow to replay the loan you are requesting? Your historical and projected cash flow will both be reviewed during the cash flow analysis and will be compared to your projected debt service requirements.  Every bank completes their cash flow and debt service coverage ratios a little different, but here is a general formula you can use:

Cash Flow Coverage=    
Net income after taxes + depreciation + interest + rent – distributions
Proposed debt obligation + CPLTD (current portion long term debt) from prior year + rent + interest

Most lenders will look at the past two to three years of your financial statements or tax returns and the most recent financial statement on your business depending on where you are in your fiscal year.  While projected cash flow is important, the lender will usually put more weight into the historical cash flow of the business and make sure it is sufficient to support the requested debt.  Projected cash flows usually show higher figures than historical performance because of the expected growth of the company.  Because of this, your lender will review these with some skepticism.  You should be prepared to defend your future cash flow projections with information that would give your lender data to show these figures are accurate, such as signed contracts or backlog information.  A typical cash flow coverage should be 1.2 or higher to meet most lender’s guidelines.  This means the company is expected to generate at least $1.20 of cash flow for each dollar of debt service. 

COLLATERAL

Collateral is important to a lender as it is the secondary source of repayment of the loan.  If the company is unable to generate sufficient cash flow to repay the loan, the lender will get the collateral and liquidate it using the funds to pay off the loan.  Many lenders want the collateral to be equal to or higher than the amount of financing provided.  Some banks may ask for additional collateral on top of the equipment they are financing in order to overcome financial or credit issues.  Many banks are only interested in financing collateral types that they can easily liquidate such as accounts receivable, inventory, equipment and real estate.  Most lenders will only use a percentage of the value of the equipment or collateral on the financing.  For example, on average a bank will generally give a business 80% of the value of their accounts receivable, 50% against their inventory, 80% against equipment and 75% against real estate.  Each bank will waiver on these percentages a little based on their historical experience in other liquidation scenarios against each asset class.  Keep in mind there are costs to liquidating (appraisals, shipping, legal expenses) or collecting (bad debt customers) on these assets and the percentages will reflect these costs also.  Most lenders will look at comparable assets to verify the true value of the asset.

CAPITAL

Lenders like to see the owner(s) of the company to have sufficient equity in the company.  Capital is important for two reasons:  1) It gives the company a cushion to withstand a blip in the company’s ability to generate cash flow.  If the company has a tough quarter or becomes unprofitable for any reason, having enough capital to weather the storm is important.  Without capital, the company could run out of cash and be forced into bankruptcy.  2)  Lenders like to see owners have “skin in the game.”  This shows the bank the owner will be motivated to stick by the company and work hard to turn the company around should anything go wrong.  There is no exact number for having enough capital.  Many banks will look at the owner’s investment into the company relative to their total net worth.  Most banks will also run a debt to equity ratio which shows how much debt the company has compared to the equity in the business.  Most lenders want to see a debt to equity ratio no higher than 2 to 3 times. 

CONDITIONS

The overall environment the business is operating in can affect the lender’s decision.  The lender will assess the conditions surrounding your company and its industry to determine the key risks facing your company and how well you can mitigate those risks.  Here are some examples of things your lender will consider:

  • Competition- how do you differentiate from your competition?  What keeps your customers working with you versus going to your competition?
  • Customers- Do you have any significant customer concentrations?  If so, how do you protect these customer relationships?  What are you doing to diversify your revenue base?  Are any of your major customers having financial issues? 
  • Supply risks- What are your relationships with your key suppliers?  Is there any risk of disruptions from them?
  • Industry issues- Are there any economic or political factors affecting your company?  What trends are emerging in your industry?

Be prepared to discuss what you see as the primary threats to your business and what you are doing to mitigate those risks and protect your company.  Make sure the lender understands the drivers of your business.  These could be just as important as your company’s financial profile.

CHARACTER

I would argue that Character is the most important of the Five C’s.  It is important for lenders to know who they are working with; are the owners and management of the company honorable people when it comes to meeting their obligations?  Character can not approve your financing by itself, but it can make a lender turn you away by itself.

Character is tough to “grade” because it is an intangible asset.  It really comes down to the lender’s “gut feeling” about you and your business.  Your lender will get a good read on this based on your personal credit bureau report and how you handle other debt obligations.  The lender can pull business reports on your pay history and will also communicate with your current and former bankers and suppliers to find out how you have handled your arrangements in the past.  The lender may talk with your customers or past business partners.  How you handle yourself with the lender during the application process also plays a big role.  Most lenders will only work with people they can trust; in good times and in bad times.  The lender wants to know that if things go wrong, you will do whatever you can to honor your commitment to them. 

Take the Five C’s and make sure you are ready to present to your lender on behalf of your company when the time comes for you to apply for financing.  Being prepared and having your Five C’s in line will help your process go quicker and smoother.  You can also use these Five C’s as a management tool to aid you in running your company.

Visit my profile on Linked in:  Carrie Radloff

January 7, 2010

A Good Credit Score Isn’t What It Used To Be

Filed under: Credit tips — Tags: , , , , , — afp @ 4:04 pm

credit score chart

If you applied for a mortgage a couple of years ago with a 620 credit score you were good to go.  If you applied for a commercial lease with a 650 or above credit score and had 2 years or more time in business, you could be approved upwards of $150,000 with just a signature.  That same commercial business today might have a problem getting approved for $25,000.  In the past, any credit score over 700 would get a huge smile and thumbs up from your credit officer.  Now, if your credit score is below a 740 you might run the risk of not being approved or having an increased rate due to your “lower” credit score.   What used to be considered great is now only good and people are paying higher interest rates or making some changes to their credit to increase their scores. 

Here are some examples that I have run into in the past month of how people have been directly affected by their credit scores:

1)       I had a customer who was a 739 score when we funded a deal for her in October 2009.  When we repulled her credit bureau recently her credit score had dropped to a 698 because she put a new washer & dryer on a store credit card.  That increase in her revolving debt totals caused her available revolving debt to lower and the combination of the two made her score go right under the 700 mark that many banks require.  She was still approved for her lease, but at a higher rate than she had expected.

2)       A repeat customer came to us for another $20,000 lease for a new trailer.  His credit and pay history in the past were very good.  When we updated his credit there was an auto loan showing past due with a lot of recent slowness.  We found this was an auto loan he had co-signed for his son who wasn’t paying well.  Because of this auto loan derogatory, his score went to a 632 and we were not able to get him financed at a competitive rate, even though he handled his own credit perfect and paid all of his business debts.

3)       Credit bureaus and banks are now penalizing specific geographical regions due to the high delinquency and bad debt they have experienced in them.  I had a customer who was approved 6 months ago with a bank and decided to hold off on the equipment at that time.  When he reapplied recently his credit was the same, but the same bank would not approve his loan because he lived in Florida which was now a restricted state for that bank.

So what can you do to make sure your credit score is where you want and need it to be? 

There are a number of steps you can take yourself to help raise your score anywhere from 10-20 points or more in a short period of time:

1)       First, you need to know what your credit score is.  There are several sites where you can get free credit reports.  Just beware of pitches for over-priced credit-monitoring services, which can cost more than $100 a year.

2)       Correct any inaccuracies- Consumers can improve scores on their own, but I would caution anyone doing it themselves to make sure you do it properly.  If done incorrectly, it could cause you to not be able to fix it in the future.  There are credit agencies who offer clean-up services that can be recommended to you.  We have a company I could refer to you who charges a minimal fee and will do it right the first time (http://www.newwestcc.com/default.htm).  This minimal $295 fee is easily recouped by lower interest rates on your future finance agreements and leases.

3)       Decrease your revolving debt totals and increase your available credit.  This can be done by paying down balances or increasing credit limits.  Ideally, you should keep all of your open credit card balances from 0% to 30% of the total available credit.  Do not close the credit cards you have $0 balances on, keep them open even if you do not plan on using them. I’ve seen people increase their credit scores by 90 points or more just by paying off the right credit cards. 

4)       Limit inquiries and who pulls your credit bureau report.  Every time your credit bureau is pulled it can affect your score.

The most important recommendation I can give is to know your credit bureau score and to monitor it on a regular basis.  When you know you are going to be looking for financing in the near future, check your credit bureau and clean up any potential issues before you apply at your bank.  Talk to the bank you are looking to use to find out what their guidelines are so you can make sure the application and approval process goes smooth for you.  For more information on this topic and to get a free credit bureau report, visit https://www.annualcreditreport.com/cra/index.jsp.

November 24, 2009

Tips to reestablish credit

Filed under: Credit tips — Tags: , , — afp @ 2:56 pm

There are a number of ways to reestablish credit, some good and some that simply take too long and are not very effective.  I will address some of the most common methods, noting both the positive and negative aspects of each.

Secured credit cards: This method is both costly and time consuming. Keep in mind that all types of credit are “rated” differently and this is one of the lowest rated types of credit and the time frame it takes to develop a “history” for the account makes for a long process of improving your credit. 

Department store credit cards:  This type of credit is usually easy to qualify for as their guidelines are usually less strict than for other types of credit.  With that said, keep in mind that again, they are rated lower then other types of credit and it takes a long time to develop a “history” for the account and is thus a time inhibited approach to quickly increase your credit history while improving your score.

Find someone to cosign for you:  This is one of the better choices to quickly and effectively increase your credit score.  It does require that you have a close friend or relative that has trust in you and good credit at the same time.  It also goes without saying that you must meet your financial obligations and not default as the creditor will then go after both parties for full payment and could potentially hurt both of your credit ratings.

There are a couple of points to keep in mind while utilizing any of these techniques.   Make sure that the company you are working with regularly reports to the three major Credit Reporting Agencies: Experian, Equifax and TransUnion.  Also, keep the balances on any of these accounts to a minimum.  A high “Debt to Credit Ratio” (balances divided by the credit limits) is a very large factor in the algorithm that is used to calculate your credit score…the higher the ratio the more negatively it will affect your score!

October 27, 2009

What factors are used to calculate credit scores?

Filed under: Credit tips — Tags: , , , , , — afp @ 9:18 am

Although credit scoring models were being developed as early at the 1950’s, their actual widespread use didn’t fully take effect until the early 1990’s. Fair Isaac Inc. or FICO as we all know them were the first to take these mathematical models or algorithm’s as they are sometimes called and begin selling them primarily to the three major bureaus (Equifax, TransUnion and Experian).  Since that time Fair Isaac has and continues to develop many different scoring models for different industries. For our purposes here we will go over the basic elements which are factored into your credit score. 

Payment History-  Approximately 35% of your score is based upon this category.  If you are late with any creditor the most important thing to keep in mind is to get current and stay current. Also, keep in mind that paying off an old collection or charge off will not remove it from your report, since this negative information stays on your report for seven years based upon “date of last activity” you have just “restarted” the seven year clock and now will be legally reflected on your reports for seven more years! The more serious the late payment information the more detrimental effect it will have on your score.  For example one thirty day late is obviously not as serious as a ninety day late regardless of the type of creditor. Another important fact is that different types of late payments decrease your score according to the type of creditor.  In other words, all things being equal one late payment on your home loan is more derogatory then a late payment on your credit card. 

Amounts Owed-  Approximately 30% of your score is based on this category. This is what we call “a debt to credit ratio”.  Simply put, this is the balances divided by the limits on your revolving lines of credit…ie credit cards.  Ideally, the credit scoring system would like to see this ratio below 30%.  If the ratio is 30-50% it will it will slightly lower your score, 50-70% will begin to more significantly lower your score and anything over 70% you may see your score tumble! 

Length of Credit History-  Approximately 15% of your score is based on this category. As a general rule a longer credit history will increase your score, yet, since this category only comprises 15% of your score we regularly see people who only have a couple of years of credit history who are “A” credit borrowers.  This means they have many other positive factors with a greater effect.  Keep in mind when opening new accounts not to open them too rapidly as this will lower your average account age which will thus lower your score. 

New Credit-  Approximately 10% of your score is based on this category. It’s no secret that Americans have more credit (and thus credit debt!) then any country in the world. As established before, all types of accounts are rated differently so it is advisable to shy away from accounts such as department store or secured credit cards as they are rated much lower then most types of credit. Our company for instance, utilizes methods which can expedite better credit with higher rated credit in a much shorter period of time for those people looking to establish new credit. 

Types of Credit – Approximately 10% of your score is based on this category. Again, here is a category without much weight in the overall picture but is still a factor. Since all types of credit is scored with a separate degree of importance it just makes sense to stay away from too much credit and to only open accounts that are needed. 

This article was written by Tom McKee, owner of New West Credit Consultants.  New West Credit Consultants has 24 years combined experience working with credit, credit scoring and knowledge of applicable Federal Trade Commission laws.  Tom can help increase your credit score.  To contact Tom for a free credit analysis, call him at 800-900-7481 or e-mail him at tom@newwestcc.com.

October 5, 2009

Is your business credit headed for a heart attack?

Filed under: Credit tips — Tags: , — afp @ 10:44 am

Knowing and understanding what your business credit looks like is crucial for any business owner.  More and more businesses are financing and leasing equipment among other items to keep cash flow alive in their businesses.  Knowing how your business credit looks can help make credit approvals quicker and easier, it can help you obtain a lower rate of financing, and it can help you promote your company in the best light possible the first time around.  Most important, by knowing what your business credit looks like and keeping it satisfactory, it could prevent your business from experiencing what I call a business heart attack.

In simple terms, business credit can be broken down into four main areas:  business reports, personal credit bureau reports, bank and trade references and financial information.  I am only going to talk about the first three areas in this article.

Business reports such as Dun & Bradstreet, Experian, Manta and Paynet are used by banks and finance companies to verify how long your business has been operating, who the owners and officers of the company are, how many employees you have, your past payment trends, public filings such as suits, liens, judgments, bankruptcies or UCC filings and sometimes financial information.  Business owners should get a copy of their own business report, read through it to understand what it says, and be ready to make any corrections as needed.  If your business does not have a business report, it will be important for you to be able to verify your business in directory assistance or yellow pages, verify your company’s website and if you are a corporation or LLC verify your secretary of state information.  If any or all of these are not available, you may have to provide additional information such as a business license, copy of your phone bill, or a business tax return.

There are three reporting agencies for personal credit bureau reports:  Equifax, Experian and Trans Union.  Not all bureaus report the same information or report that information in the same way.  I encourage all business owners to get and keep a current copy of your personal credit bureau report and know who is reporting what on there.  Credit bureau scores range from 300 to 900 and gives details on how you currently pay your bills, how you have paid your bills in the past and what financing you have used in the past or are currently looking for now.  Some of the items that will show on your credit bureau report include installment debts such as mortgages and autos, credit card debt, any payments made over 30 days late in the past, collection accounts, chargeoffs, public filings such as bankruptcies, suits, liens, judgments and inquiries (shows who has pulled your credit and when).  Most banks today want your personal credit bureau score to be over a 700 to 740 in order to loan you money.  If your credit falls below that, there are things you can do to help increase your score.  First and foremost, pay your bills on time and do not over extend yourself.  It is also a good idea to pay down on your credit card balances.  Credit experts recommend keeping your balance on every credit card to 10% or below the maximum credit limit.  Do not close credit cards you do not use, keep them open so they will allow more availability on your total credit card balance.  Limit inquiries by limiting who pulls your credit bureau and why.  When you start looking for financing, never “shotgun” your application out by letting several companies pull your credit.  Errors can report on your credit bureau report which is why it is important to check your credit on a regular basis and quickly fix any inaccuracies or errors. 

Every business should have a current bank and trade reference sheet available.  This reference sheet should include your business legal name, address, contact information such as phone, fax, email and website, a list of the officers, your tax ID number, your secretary of state information if applicable, your DUNS # (from your Dun & Bradstreet report) if applicable, your main banking institution listed with account number(s) and contact, 2-3 of your major trade references (who you purchase supplies from on a regular basis) and 2-3 comparable credit ratings (who you have financed things through in the past; this could be from your bank or outside bank/leasing companies).   

To help your business obtain the financing you need when you need it, have a business financial package ready to go that includes a write-up of the history of the business, your bank and trade reference sheet I explained above, a description of the collateral you are trying to finance including any cash flow savings it will bring to your business and a copy of the quote or invoice from the vendor. 

If your business would like a free 15 minute consult on how to build your business credit, please contact me at carrie@financewithafp.com or 877-237-7287.  Don’t let your business credit cause a heart attack for your business!

AFP Talking Finance