The 5 Cs of credit for business customers

A new customer wants $11,000 of stock on 30-day terms, and the signed credit application is on your desk. The bank version of the 5 Cs asks for tax returns and an asset to file against. The supplier version runs on trade references and payment history. Here is what each C means when you lend goods and time.

What are the 5 Cs of credit?

The 5 Cs of credit are character, capacity, capital, collateral and conditions: the five factors a lender weighs to judge whether a borrower will repay, and on what terms.

The FDIC Money Smart for Small Business guide defines them this way for a business borrower:

1. Character. The business's reputation and track record for repaying debts, judged from credit history, references and interactions.
2. Capacity. The ability to repay, shown by cash flow, revenue and profitability in financial statements and tax returns.
3. Capital. The financial resources the business holds, including cash reserves and assets.
4. Collateral. An asset pledged as security for the lender.
5. Conditions. External factors such as market conditions, industry trends and the purpose of the loan.

The SBA lists the same five factors for business credit without using the "5 Cs" name: creditworthiness, credit capacity, capital invested, collateral and company conditions. Banks and credit unions explain them from the lender's side. A supplier reads them from its own ledger.

How do suppliers use the 5 Cs of credit?

A supplier applies the same five Cs to a customer asking for trade credit, and swaps the bank's evidence for its own: payment history, trade references, a bureau report and the terms it sets.

A bank lends cash against a fixed term and a filed security interest. A supplier lends goods or services on open terms, and holds no collateral unless it asks for a guarantee. So the evidence changes, and most of it already sits in your ledger.

The supplier column follows Dun & Bradstreet's description of trade creditworthiness: capacity is the financial capacity to pay invoices, character is whether the applicant seems willing to honor the debt, and collateral is asked of a buyer with a shaky credit history. The first column of evidence, your own invoices, is the only one that is free, current and about your own account.

One customer read across the five (an example).

• Character. Pays 15 days late on average, with a fifth of the balance overdue by 10 days. On the Paidnice scale that scores 78, Good.
• Capacity. About $2,500 outstanding against a $7,500 limit, so there is room.
• Capital. No financial statements requested on a line this size.
• Collateral. A guarantee signed on the application.
• Conditions. Net 30, orders of about $2,500 a month, a stable trade. Decision: keep the limit, and shorten the term if the next invoice slips.

Which of the 5 Cs of credit refers to a customer's willingness to pay its bills?

Character is the C that measures a customer's willingness to pay, and for a supplier the best evidence of character is how that customer has paid your own invoices so far.

A bureau report shows how a company paid other people, months ago, summarized. Your ledger shows how it paid you, invoice by invoice, up to yesterday. Three numbers carry most of the signal: average days to pay, the share of invoices that went overdue, and how recent the late ones are.

A customer who paid 20 invoices on time and then slipped twice last quarter is a different case from one who was late in year one and clean since. Recency is part of the reading.

For a brand new customer you have no history yet, so character comes from the references and the bureau report on the application. How to check a customer's payment record covers what to ask the references.

How do capacity, capital, collateral and conditions apply to a supplier?

For a supplier, capacity is the overdue position against the limit, capital sizes the limit, collateral is a guarantee, and conditions are the terms and order size you control.

Capacity. A bank reads capacity from income and a debt-to-income ratio. You read it from whether the customer clears what it owes you inside the terms: the overdue balance as a share of the credit limit, and the average days to pay. A customer at 90% of its limit with half the balance overdue has run out of capacity, whatever its accounts say.

Capital. Capital decides how large a line to extend. Dun & Bradstreet describes 10% of net worth as a conservative method suppliers use for a trade credit limit. Financial statements are usually worth requesting only on large lines; how to set a credit limit walks through the other methods.

Collateral. A supplier holds no pledged asset. The nearest thing is a personal guarantee signed on the application, and Dun & Bradstreet recommends a guarantee for companies assessed as high risk. For a weak applicant, Allianz Trade suggests partial prepayment or shorter terms on the first orders.

Conditions. A bank looks at the loan purpose and the economy. You look at the customer's industry and region, and at the term and order size you set yourself.

What is a 5 Cs checklist for a new business customer?

Run the five Cs once at application, then rerun character and capacity from your ledger every month, because those two change with every invoice the customer pays or misses.

1. Character. Three trade references called, a bureau report pulled, no judgments or liens found. After the first order: days to pay and overdue share tracked on your own invoices.
2. Capacity. Expected monthly volume agreed, and the limit set so one or two billing cycles fit inside it. After the first order: overdue balance against the limit.
3. Capital. Net worth or owner investment noted for any line large enough to hurt, and the limit sized from it.
4. Collateral. Personal guarantee signed where the report is weak or the line is large. Prepayment on the first orders for a high-risk applicant.
5. Conditions. Term chosen, with a shorter term for a new account, order size capped, industry and region noted.

Then set the rule for what happens when the readings move. Allianz Trade's advice is to reduce limits quickly when payment behavior worsens and raise them in small steps only after consistent on-time payment. The written form of that rule belongs in your credit policy, and the stop point is a credit hold.

How does Paidnice read the 5 Cs from your ledger?

Paidnice scores character and capacity from the customer's payment history with you, on every plan, and runs bureau checks through Creditsafe on the Custom plan.

• Every customer gets a 0 to 100 credit score built from how they pay you, in bands from 80 Excellent down to 0 High risk.
• A credit limit for each customer, and going over it can trigger an escalation.
• Creditsafe bureau checks on the Custom plan, for the character reading on a customer you have never invoiced.
• Paidnice can move a customer from the good payers group to the late payers group automatically as the score falls, so a slipping payer gets a firmer reminder schedule.

Every contact starts at 100 and loses points for paying late and for the current overdue position: pays 5 days early with nothing outstanding, 100 Excellent; pays 45 days late on average with everything overdue by 120 days, 16 High risk. See credit management software for how score, limits and escalations fit together, and pricing for each plan.

Questions about the 5 Cs of credit

The 5 Cs are character, capacity, capital, collateral and conditions, and a supplier reads the first two from its own ledger.

About the editorial team

Written byDenym BirdCo-founder & CEO of Paidnice

Denym started Paidnice in 2022 after customers paying late left his own business short on payroll. He has led it to $1 billion collected on time across more than 1 million invoices, and writes about credit control, late fees and getting paid on Xero and QuickBooks.

Reviewed byJack DaffronCo-founder of Paidnice

Jack is a co-founder of Paidnice. He builds the product that sends reminders, adds late fees and takes payments for businesses on Xero and QuickBooks.