Not all banks are created equal, but there is definitely a golden thread that runs through the credit evaluation process of most registered credit providers. Nico Groenewald, head of Agribusiness at Standard Bank South Africa, recently spoke to Plaas TV about some of the qualifying criteria that are taken into account when reviewing a loan application.

The five Cs of a credit analysis

According to Nico, banks need to obtain a holistic view of your farming establishment before they can approve your loan application. The review process aims to establish the borrower’s credit risk, which in turn determines whether the loan in question can be considered a good investment.

“With any credit evaluation, we typically look at what is known as the five Cs of a credit analysis. Firstly, we examine the lender’s character so that we can establish whether going into business with this individual would be beneficial to both parties,” Nico explains. Character evaluations can be determined based on a successful prior business partnership or sufficient evidence that the lender is confident about and dedicated to his or her business.

“Secondly, we look at certain external and internal conditions that would have an impact on the loan, should it be approved. Is it a short- or long-term loan? How is the borrower intending to use the money? How much will the interest rate be? All of these factors can influence a lender’s desire to finance the borrower,” Nico adds.

Importance of collateral

The third C points to the collateral a lender is willing to provide to secure a loan. “Although collateral may not be one of our primary considerations when it comes to credit evaluations, it is nonetheless important. If something were to go wrong, any lender would want some assurance that the person applying for the loan would be able to pay back the money. Therefore, we evaluate whether the borrower in question would be able to do so,” Nico explains.

In order to ensure that the particular collateral provides enough security, the lender will want to match the value of the collateral with the loan being made. “We also determine whether the borrower has the financial capacity to take on the loan in the first place. When ranking the five Cs, capacity is right up there next to character.” Capacity refers to the farming operation’s ability to generate sufficient surplus cash to service and repay the loan.

Availability of capital

When it comes to capital, lenders look at what you have available before lending you what you need. Capital refers to the money that is available to you through savings, investments or even raising of money through a share issue or bringing on a partner to provide upfront money. “It is rather difficult for any financier to take on all the risk when it comes to a financial investment. However, if a farmer is also willing to invest a proportionate amount of his or her own capital, then this balances out some of the risk and makes financiers more willing to extend a loan. Investing your own capital also showcases owner confidence and dedication to the business,” Nico adds.

Banks take all of these factors into account. In certain cases, a lender may place additional emphasis on one of these factors, but that doesn’t necessarily mean the other factors are overlooked.

Under- and overcapitalisation

According to Nico, farmers must make sure they don’t under- or overcapitalise when securing a loan. “Overcapitalisation usually occurs when you invest too much money into your business assets which, at the end of the day, won’t generate a sufficient amount of income. In this sense it means that the farmer possesses an excess of assets in relation to his requirements. On the other end of the spectrum, undercapitalisation can impact how you use your assets, resulting in overuse, breakage or simply not being able to utilise all the opportunities, which can also influence your profitability.”

The difference between cash flow and profit

Cash flow refers to the total amount of money being transferred into and out of a business. “In your business’s financial statements you will find one page dedicated solely to showcasing your cash flow. This statement provides an overview of how you generated cash through your farming activities, if cash was generated or used as a result of investment activities (buying/selling of assets)  and if cash was generated through financing activities (raising a loan or repaying a loan).”

Profit refers to the application of accounting standards to calculate the difference between your income and your expenses over a certain period of time.

“Both cash flow and profit are important. Generating a profit forms the basis of creating a positive cash flow. If you cannot generate a profit, your farming venture will not be sustainable in the long run. You must find a balance where you manage your farming venture in such a manner that you generate both a profit and a positive cash flow,” Nico concludes. – Claudi Nortjé, Plaas Media

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