Corporate Financial Management UBA 341
Group Assignment 2
American Degree Program
SEGI University
Mr. Raymond Cross
Summer Semester
June 25, 2013
By
Shafiq Reza Bin Zulkifli (SCM-006247)
Muhammad Hareez Bin Shaik (SCM-009956)

Contents
Introduction 2
The Five C's Of Credit 3
Article of Interest 5
ARTICLE TITLE: How To Get A Small Business Bank Loan 5
Article review 7
Conclusion 9
Reference 10

Introduction

In considering the extension of a person's credit, a method called the “Five C's of Credit” is used by most lenders to determine the credit worthiness of a potential borrower. All in all, the system itself weighs five characteristics of a borrower, attempting to analyze the chances of them going default on their business. Hence forth, for business owner; the question of "What are you looking for from me and my business if I need to borrow?", are some of the most common question that they need to ask before permitting themselves to ask for a loan from lenders. That is why, while each lending situation is unique, most lenders and especially bankers will refer to the “Five C's” when they are making their credit decisions and that business owner should familiar themselves with this to insure good credit rating within their business. Following this further, the five C's of credit that is important to know are Character, Capital, Capacity, Conditions, and Collateral where each of the five will incorporates both qualitative and quantitative measures, that display a person's business portfolio("Five cs of," ).

The Five C's Of Credit

(Character) In terms of character, what must be noted is that it is the general impression that borrowers make on the prospective lender or investor (MBDA, 2009). Where by lender will then form a subjective opinion about the person and deduce whether or not they are qualified as an integrous person, whom is trustworthy to repay the loan or generate a return on funds for the lender. All in all, the general points that lenders will look for in borrowers are integrity as well as moral and ethical quality of the individual (Hirt, Block & Danielsen, 2011). Continuing this further, even a person educational background, experience in business, and even the industry by which the business is in, will also be considered. At this level, although it may sound as extreme, lenders will also do a search regarding the quality of the business's references as well as the background and experience levels of their employees.

(Capital) When capital is involve, what should be known is that it is the money that a person have invested within the business itself and that, it is an indication of how much that the person has put a stake in, whereby the more they have at stake, the more risk they will incur if the business fails. Hence, that is why lenders will look at this and identify how serious is the borrower with their business. By which the lenders will feel more comfortable if the borrower has more at stake than them, as they can estimate the level of commitment that the person has invested.

(Capacity) In regards towards capacity, what lenders usually tries to find are the information that determine whether the business can comfortably manage their payments. This mostly refers to the ability of a business to service their debt and as well as replace their assets as they wear out (Loo, 2009). It can be debatable, but capacity can be considered as the one of the most critical attribute to the five factors in face of lenders, as it determines how efficient the borrower in paying of their debts, and in this case, the loan to the lender. Undoubtedly, lenders will then considerably deduce the cash flow from the business, the timing of the repayment, and the probability of successful repayment of the loan. Where by payment history on existing credit relationships either personal or commercial is considered an indicator of future payment performance. At best, capacity will ultimately determine for the lender the punctuality and competency of the business owner in settling of their debt.

(Conditions) To begin, what can be said about conditions are that, it refers to the sensitivity of the operating income and cash flow of the economy (Hirt, Block & Danielsen, 2011). Assuredly, even if all the criteria are passed, conditions may eventually prevent a lender to forward a loan. This is mostly attributed to the general state of the market, consumer trends,economic predictions, and as well as environmental considerations. All in all, what can be said is that, the more sensitive the cash flow of the business is towards the economy, the more the credit risk that the they will face, by which, that will ultimately decide the lender's leeway.

(Collateral) With all business, collateral plays a huge role in establishing a certain confidence between the lender and the borrower. Although the word may sound big and can be mistaken as something that is uncommonly practice, people everyday experience it once or twice in their daily transaction. In the business sense, although cash flow will nearly always be the primarily source of repayment of a loan, lenders and bankers will likely see to what they call as a secondary source of repayment (Collateral) to establish concrete confidence with the borrower. Usually collateral represent the assets that the borrower pledges and that unless the borrower is a business with a proven payments track record, collateral will almost always be required as a guarantor. Where by, this act will limit the ability of the borrower to make other borrowing decision and reduces the speed of establishing the borrower's line of extending credit.

Article of Interest

ARTICLE TITLE: How To Get A Small Business Bank Loan

Author/Publisher: Jerry Chautin
Source: http://www.huffingtonpost.com/jerry-chautin/the-five-cs-of-lending-ar_b_839679.html
Date of Published: March 24, 2011 Capacity, capital, collateral, credit, and character are the "Five Cs" that loan offers learn in Lending 101. But to most small-business loan applicants in need of money, it is an esoteric exercise that makes them garner reams of paperwork without a clear path to funding.
Financing a business "is based on a simple principle," Charles Green says. He founded a community bank in Atlanta, Georgia, received a financial services award from the U.S. Small Business Administration for making lots of small business loans and recently published his third edition of The SBA Loan Book. The simple principle, he says, is "lenders always require the borrower to agree that the loan will be repaid." If it were that simple, of course, all applicants would walk out of banks with wads of cash.
Bankers want a comprehensive business plan supporting "your ability to repay the loan," Green says. "The lender will expect you to provide realistic projections about how the proceeds of the loan will be invested to generate revenues for your business." Furthermore, the revenues generated, less the business operating expenses, must be sufficient to make the loan payments. Additionally, lenders require a cash-flow cushion should revenues decline or operating expenses increase. The projections and an extensive narrative about how you arrived at your numbers is the crux of your business plan. Yet many loan applicants are stumped when it comes to projecting income and operating expenses. To help, most SCORE chapters are offering a course called, "Financial Projections." It is part of their QuickSTART workshop series and explains how to project believable numbers.
Believable means that your projections and financial ratios must pass muster with the bank's underwriters. Moreover, the underwriters have to accept your narrative describing how you arrived at the projections.
"The integrity and reasonableness of these projections are often the most important factors in granting loans approval," Green says. Paradoxically, "The lender is not an expert in your field and may not recognize exaggerated revenue projections or inadequate expense estimates." Even more perplexing for underwriters, small businesses within the same industry can be very different. That is why projecting your numbers and getting the lender to buy into them is as much an art as it is a science.
The science is learning the lender's acceptable range for key financial ratios in your industry. The art is doing impeccable market research and citing it as the rational for getting your projections to fit. In other words, you have to know the benchmarks that your lender uses. Then, extensive research and the resulting narrative will support your projections. Many lenders use the Risk Management Association's "RMA Annual Statement Studies Users Guide" to glean average financial ratios by industry. Thus they will match your projections against others in similar businesses. Any variances from RMA need to be explained. Furthermore, your proficiency in explaining the variances can mean the difference between approval and rejection.
The trade associations in your industry will likely have average and mean financial ratios in your industry. They may also segment businesses within the industry more definitively than RMA. You can find a list of trade associations in the Encyclopedia of Associations. Many libraries have it in their reference section or you can purchase a copy online. Green, the former banker, says, "Companies may not compare well with RMA results because of extraordinary local reasons." So get data from local chambers of commerce, business owners and franchise operators merchandising similar products and services. Interpret the data to explain how your company differs from RMA's averages.

Article review

The main highlights of this article are the 5Cs which are capacity, capital, character, credit, and collateral. These are the basic concept of credit standards that would be question by Banks and are rules that small firms need to determine whether they are essentially qualified to start a venture. According to Charles Green, who is the founder of a community bank in Atlanta, Georgia, he states that “Banks always require the borrower to agree that the loan will be repaid. If it were that easy, of course, all applicants of loans would walk out of banks with a wide-grin with tons of cash.” His statements are agreeable, because firms need to gain financial institutions and intermediaries’ (Banks) trusts. This is basically risky for Banks because, with a huge level of default-risk involved, only can they be able to gain interest. To add more to the damage, to accommodate payments by small firms, occasionally loans repayment period are lengthened. These small firms should also understand that banks also deploy its funds in other form of banking services. One of them is the Money Market in which it provides lower default risk, higher possibility of higher yield on investment in a shorter duration within a year, and has a relatively high degree of safety. Eventually, the Banks will regulate the money market through the offering of instruments such as the negotiable certificate of deposits (CD’s), Bankers Acceptance, Treasury Bills, Commercial Paper, & Repurchase Agreements (Repo). (MoneyControl, 2013) However on the context of firms securing a small-business loan which can be categorized into 2 types, Business Loans & Consumer Loans, they believe that they will face difficulty to secure funding as they have a major task of preparing tons of papers. The papers are important documents that could guarantee or prevailed the lender of securing a loan. It includes the Statement of personal financial earnings, a detailed Business Plan, A repayment plan, Credit report, a statement of collateral, and Proof Equity. Bankers definitely wants a comprehensive business plans of firm’s to fulfill the repayment which are reflected through the firms primary objective, its repayment strategies, Income projections and ways of gaining additional capital resources other than from Banks. The lender definitely would expect borrowers to list realistic projections on the firm’s methods of proceeding loan funds to generate revenue so that borrowers (banks) have the insight and understanding on the historical timing of consecutive payments. In addition to that, a factor that needs to be considered by the borrower is the cash flow cushion effect in which the product of revenues obtains minus firms operating expenses of the firm must be sufficient enough to encourage payments according to the agreement. But, as described from the above article, new entry firms are puzzled on how they would be able to project income and future expenses. According to the article, to comply with borrowers, small firms need to showcase believable projection figures and financial ration before an agreement is agreed with the banks underwriters which are actually difficult to predict. On the other side of story, as the lender does not have the co-competence in the field that they are considering to jump into and still consider themselves as a green horn, it would be hard to them to critically analyze and portray exaggerated revenue projections and estimate insufficient expense. Nonetheless, to understand the concept, majority of first time entrepreneurs base their understanding on Risk Management Associations (RMA) by gathering average gathered financial ratios from the industry. By understanding the concept, they can concurrently match the firm’s projections against other firms that are in the same market industry. Thus, any further discrepancy from RMA that they face along the way should be resolved immediately to improve efficiency in order for to be considered for the business loan.

Conclusion

To conclude, what we have learned from the research from the 5cs of credit is that it is one of the most important criteria that a firm needs to be obliging towards the borrower (banks, financial intermediaries).Borrowers tend to choose lenders based on their creditworthiness. This includes of Borrower (Banks) investigating on prospective entrepreneurs in the aspect of Payment History, Amounts Owed, Length of Credit History, New Credit, & Types of credit used. A banker especially wants these small firms who face tight budget constraints to be committed enough to resettle the loan. On the other hand, to satisfy the requirements that are set by banks, new Firms need to reflect upon themselves while maintaining a certain budget ceiling before considering of applying a loan.
Without relatively anything to gain from the agreement stated based on the terms and conditions, no borrower would want to risk of getting scam by lenders! Therefore, banks managers need to evaluate & reevaluate in detail whether or not they could grant loans to small firms. Based on our understanding regarding this matter, Financial Managers needs the 5CS as they need to showcase a certain standards reflecting on the inventory turnover, achieving targeted Sales figure, & Maintaining Short-Term Obligations to woo in potential investors after a period when the business had been stabilized. Example: On the context of a business owner, they should realize prioritizing on their credit standards important as loans are difficult to obtain because of the high competition nature. First and foremost, an initiator of the business should build a strong reputation and support from the community or industry that they are venturing into. This extra tool could be an upper-hand in securing a Bank loan. A simple example would be for an individual to set up a restaurant serving Malay Delicacies. This individual has prior working experience serving as a Top Chef in a reputable Hotel & Resort in KL. Probably he/she has an upper hand in the industry and community as knowledge and experience is very important. On top of that, having a Guarantor are another criteria that Banks usually look upon. If let’s say, the initiator of the restaurant business can provide guarantee that his/her Guarantor is financially stable and have credible credit history, the initiator could face less difficulty in gaining a huge loan package as Bank would predict that lesser risks are involved in the agreement.

Reference

Five cs of credit. (n.d.). Retrieved from http://www.investopedia.com/terms/f/five-c-credit.asp
Hirt, G., Block, S., & Danielsen, B. (2011). Corporate finance foundation. (14E ed., p. 231). NY: McGraw-Hill.
MBDA. [Web log message]. Retrieved from http://www.mbda.gov/node/438
Gwen Moran (2011), How to Check a Customer’s Credit Worthiness, Retrieved on 8 July 2013, from http://www.entrepreneur.com/article/218126
Brian Hamilton (3 Jan 2013), Are you Creditworthy? How Personal Credit and Business Credit Impact Your Company, Retrieved on 8 July 2013, from http://yfsentrepreneur.com/2013/01/03/are-you-creditworthy-how-personal-credit-and-business-credit-impact-your-company/