A bank’s decision to lend money to a borrower is not rocket science.
The final decision is made based on five founding principles. At the core of any loan process is a credit analysis to determine the risk associated with making the loan and the likelihood of repayment.
In business financing, it is not just a matter of evaluating the business, but also the borrowers associated with its ownership and operations.
Most credit analyses use the five C’s to evaluate the risk of a loan:
- Cash flow
Documents such as tax returns (individual and business), personal financial statement (PFS), resume, interim profit and loss statements, balance sheets and a business plan help paint the picture of a borrowers five C’s.
Below we’ll explain each of these categories and discuss why pharmacy owners should pay attention before seeking financing for their pharmacy.
Character: Can a bank trust you?
From each interaction, the bank is determining honesty and integrity.
Lenders need to be confident that the applicant has the background, education, industry knowledge and experience required to operate their pharmacy successfully.
This all amasses to answer the question of “can we trust that you will be able to run this business successfully and pay back our loan?”
Business owners have a personal financial history that can help paint a picture of their (likely) future behavior.
There are many factors that influence loan approvals, and personal finances and credit can have a significant impact on your ability to borrow money for business purposes.
Your credit report is your track record of prior debt repayment. It compiles your debt story in one place then tells a reader how successful you are at paying your debt back.
Balances, credit limits, and payment history are reported from your credit cards, student loans, mortgages, car loans or other lines of credit.
Payment history is one of the most significant factors in your credit score.
Capital: What is your investment?
When asking to borrow money from a lender, they’re going to ask what personal investment, or capital, you plan to make or have already made in the business.
Contributing personal assets demonstrates that you are willing to take a personal risk for the sake of your pharmacy business; it shows that you have ‘skin in the game.’
To assess your personal financial position, the lender will request a PFS; this shows a summary of your assets, things of value you own, liabilities, debts or obligations. It also indicates your financial responsibility.
From these numbers, you are then able to calculate your net worth, which is assets minus liabilities.
Accumulating credit card debt, even in smaller amounts, can appear as a less favorable type of spending behavior than larger student debt balances used to invest in your education or a reasonable mortgage for a house.
Savings are important as it shows the lender that you are living within your means.
Conditions: What is the money being used for?
To the lender, conditions represent what the money can be used for and the overall health of the industry.
Many things factor into how the lender evaluates the conditions.
The premise is that they are gaining a perspective on what the loan will be used for, what will be taking place, the status of the business, as well as the status of the profession and marketplace economy.
Lenders like to see positive trends and robust business plans with a thoughtful plan for growth and continuity.
Common reasons for pharmacy financing include: acquiring an existing pharmacy, expansion, renovations, prescription file buys, working capital and refinancing existing loans.
Collateral: What if you don’t pay back the loan?
A lender has to consider the worst-case scenario. What happens if the borrower chooses not to pay back the loaned money?
Collateral acts as a secondary source of repayment. A lender will consider the value of the business’ assets and the personal assets of the guarantors as potential collateral for the loan.
Collateral also acts as a psychological motivator, as people tend to get more resourceful when they have something to lose.
Cash flow: How will you pay it back?
To approve the loan, the lender wants to get comfortable with how your pharmacy will be able to repay the loan successfully.
With business loans, the repayment ability is coming from the performance of the business being evaluated and the state of their cash flow.
You should have sufficient income to support your business expenses and debts comfortably while also providing principals’ salaries sufficient to support personal expenses and debts.
Cash flow management is an imperative skill for any small business owner.
There is a lot to prepare for when looking to obtain a loan. Always remember character, capital, conditions, collateral and cash flow as the pillars of a typical credit analysis.
Start reviewing these five areas to help the lender evaluate your business to better understand the risk of making the loan.