Five C’s of Credit for AR Factoring Versus a Bank Line of Credit
In the commercial lending world, the main choices are AR Factoring vs a Bank Line of Credit, there are five key focal points that are considered in both before credit is granted. The five C’s of credit is a system used by lenders to evaluate the creditworthiness of potential borrowers. These principles can be listed as follows:
- Credit Score
What is the “Five C’s of Credit” concept?
To evaluate a potential loan or factoring facility, banks, factors, and commercial lenders weight five main keys (character, capital, collateral, capacity, credit score/ conditions) in an attempt to detect any chance of default. This system helps lenders to make consistent funding decisions in accordance with both their institution’s rules and the 5 C’s’ parameters as stretching this system beyond its limitation would only lead to critical risk potential that is not worth taking. In fact, this method is both quantitative and qualitative as regardless of where the business is trying to seek funds, either from a bank or any different financial institution, the prospective lender will verify its eligibility and creditworthiness by looking into the business’ financial reports, credit score, income statements and all other documents indicating the business financial situation, along with information about the loan itself. Therefore, a complete documented funding request that includes a business plan will be helpful as the lender can understand both the owner and the business needs.
The five C’s of credit are very critical as each funding request needs to be tested against these five elementary lending criteria in order to determine the deal’s potential. A lender will base its decision only, and only if he feels comfortable with the prospective borrower’s subjective strengths’ and weaknesses’ combination of these criteria.
The five C’s of commercial lending can be described as follows:
1. Capacity: The lender attempts to determine the borrower’s eligibility and qualification to obtain funds based on his effort, ingenuity and perseverance in generating continuously profitable business revenues. In fact, the business resume, credible strategic decisions, prior financial accomplishments, and successes can positively contribute to boosting its capacity to obtain a loan.
2. Capital: The lender attempts to verify the borrower’s adequacy of investment by requiring a meaningful capital amount at risk in order to ensure its commitment to venture and reduce lender’s exposure to loss. The lender will review the business’ operation nature, position, proceeds, availability, and worth of collateral. The lender will also watch the business equity as its profits grow.
3. Collateral: The lender attempts to quantify the borrower’s ability to support the funding request with assets that can constitute a backup repayment source. Lenders will typically secure the loan based on the discounted value of assets in order to secure an excess safe margin to cover time costs when converting the depreciated assets into cash. This excess margin value has to always be equal to or exceed the balance or the requested funding.
4. Credit Score: The lender attempts to evaluate the business’ past history performance as a borrower to ensure his previous borrowings have been fulfilled according to agreed terms as well as verify whether the business has any civil judgments against them, unpaid tax liabilities or sought protection against bankruptcy. The lender takes its decision based on the borrower’s past behavior in taking seriously the responsibility of repayment.
5. Character: The lender attempt to evaluate the borrower’s integrity and trustworthiness by observing and studying his attitude to determine his personal qualities and characteristics. A character is a subjective criterion but the most important so far to determine the borrower’s eligibility for funds.
How do banks vs AR factors handle the 5 C’s to make a decision?
Regardless of whether a business is seeking funds from a bank or from a less traditional institution such as factors, the company needs to prove its worthiness to secure the funding by meeting set requirements that have mainly been summed above in the 5Cs concept. The difference on how banks and factors make their decision based on the five Cs can be established as follows:
When it comes to this criteria, both banks and factors tend to have the same behavior because of the subjective nature of the requirement itself. In order to grant funding, either the factor or the bank need to feel comfortable trusting the prospective borrower.
Traditional Credit or Loan: Bankers will evaluate the business background and character to determine his eligibility to receive funding.
A/R Factoring: Factors will review the integrity of the company and its management and ownership team. The fundamental questions would be: Will they do the right thing while dealing with both the marketplace and with the factor as a funding source? What patterns are evident in their past relationships with lenders?
Traditional Credit or Loan: Lenders typically evaluate borrowers’ sources to pay back their loan, and will request proof of financial documentation of the resources they hold.
A/R Factoring: Factors evaluate the quality of the business’ clients as well as the transporting amount it does. Your capacity depends on the number of invoices you are holding as you would have already completed the work and simply awaiting payment.
Traditional Credit or Loan: Bankers attempt to define how much of the business own capital is to be invested when assessing its eligibility for a line of credit as the more they invest the better candidate they are.
A/R Factoring: Factors focus on your customers instead of the business itself. The business capital is not really taken into consideration as a factoring business would focus on turning the business client solid account receivable into a solid capital.
Traditional Credit or Loan: Should the business fail or default on the loan, bankers need to have secured a secondary source for recovering the loan. Therefore, bankers focus on your tangible assets such as real estate and capital equipment in order to tie them to the loan itself.
A/R Factoring: Factors consider invoices as collateral, meaning that they evaluate the business’ client’s creditworthiness instead of the business itself as they are the one liable to pay back.
Traditional Credit or Loan: Bankers analyze the business credit history and the track record it has established when making repayment to the past lenders that have extended credit to them. In addition to the business credit reports, bankers pay attention to its credit score included in the credit report as well that is usually expressed in a numerical value (between 300 and 850)
A/R Factoring: Once again, factors focus on shifting the credit risk by analyzing the business clients’ credit score instead of the business creditworthiness. Therefore, if your business and you have a poor or limited credit scores but your customers are creditworthy, you are most likely able to get the funding you need.
Why choose A/R Funding?
A/R Funding is an alternative funding source to any business lacking enough credit score to be eligible for a bank loan. In fact, A/R Funding is a viable funding source for companies that can show strength in character and collateral only. Factors will not only shift the credit risk to your customers but also provide you with complimentary credit checking services as well as credit protection.
Our team is resourceful, flexible, and reliable, and our goal is to fund you fast. Feel free to contact us today to discuss your specific needs.