OPEN Book Insight: Building and Protecting Business Credit
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Given the tightening of credit in the economy, it's more critical than ever for business owners to be vigilant about managing their credit. Lenders consider a variety of factors when evaluating your business credit, including both your personal and business payment and credit history.
It is difficult to predict when your business will need to borrow, so savvy businesses work toward demonstrating responsible credit management long before funds are needed.
Here are some steps you can take to help ensure that your credit profile prepares you for borrowing.
Demonstrate good debt management skills
In order to build a credit history you need to use credit. Look for an opportunity to borrow money at a time when your business can use the funds responsibly and pay them back quickly. These good borrowing habits and proven ability to repay can help provide a solid foundation for future borrowing.
A key part of successful debt management is using borrowed funds for the right purpose. Good reasons to borrow include covering a temporary cash flow shortage and financing growth. In these cases the funds for repaying the debt should be clearly identifiable and could well justify the risk of borrowing.
Less ideal is taking on debt to dig out of a financial crisis or to fund payroll. In these cases, unless you have funds earmarked to repay the loan, taking on debt can be risky.
Use the right financial tools for the job
Managing your credit is easier when you understand the intended purpose of various financing tools. Use the following list as a guide.
1. Use charge cards when you can pay off purchases in full by the end of the month so you don't have to pay for access to the capital, e.g. interest.
2. If you want to carry a charge over several months, consider using a credit vehicle that lets you pay off interest but keep a revolving balance.
3. A line of credit can help you smooth cash flow, make seasonal purchases or manage short-term cash crunches.
Be careful, though, about using it for long-term debt.
4. For more costly purchases such as capital equipment or real estate, a traditional loan, with its fixed payment schedule, might be most appropriate.
5. Use business credit cards for as many purchases as possible.
Although you may pay a fee for the card, the purchases you can make with accrued points will likely offset any usage costs.
Understand lenders'guidelines
Like you, lenders want to minimize risk. They often use criteria called the "5 C's" to assess a company's creditworthiness. Consider how your company performs in these areas to help put you in the best light when applying for financing:
1. Character — What is your company's credit history? How likely are you to repay the loan?
2. Capacity — Is your company's cash flow sufficient to meet current and prospective loan or lease commitments?
3. Collateral — What non-cash business assets, such as equipment, real estate and inventory, can be used to secure a loan?
4. Capital — What's your personal net worth, or the net worth of your business?
5. Conditions — What outside factors such as economic conditions, competition and the like may affect repayment?
Minimize bad credit risks
Slow-paying customers can impact your ability to access capital. Irresponsible vendors can have a similar impact. Take steps to protect yourself from the "wrong" kind of business associate by checking references on prospective partners, customers and vendors. Stay on top of your customers to encourage on time payments by sending notices when a receivable is due or late. Consider accepting credit cards, which can both lower your exposure to late payments and increase the timeliness of your receipts. Credit card companies can also act as intermediaries should a dispute arise, and potentially assist you with fraudulent charges.
Separate business and personal credit
While many business owners find their personal and corporate finances linked, it is important to keep these as separate as possible.
Avoid commingling business and personal assets. Set up business savings and checking accounts. Have a dedicated business charge card account, as well as separate business loans and credit lines. Separation has two major benefits - it helps your company establish a credit history, and it can reduce the impact that a business problem can have on your personal credit. Be aware, however, that many lenders will closely examine the personal credit history of a company's owners before approving financing.
OVERVIEW: A BUSINESS CREDIT REPORT
Like your personal credit history, your company's credit rating is determined by credit reporting agencies - independent companies that assess your credit "score" based on factors such as payment history and debt load.
Here is how business credit ratings differ from personal credit ratings.
— Your business score is based primarily on the timeliness of payments.
— Unlike personal credit, having multiple active accounts can be a positive, provided that they are in good standing. It demonstrates that your business is savvy about managing its finances.
— Some information in your business profile may be self-reported, which is typically not allowed on personal reports. You do this by establishing a profile with the credit bureau; consult their websites for details.
— Business creditors are not required to report payments to the bureaus, so if you're interested in building a good rating, ask vendors if they are willing to report your payment performance.
As is the case with your personal credit, it is advisable to obtain your company's report from the major reporting agencies (see below). Note that there may be a charge for this; details are available on their websites or by calling them directly.
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Understanding Your Company's Credit Report
What should you look for when reviewing your company's business credit report? You want to check accuracy while gaining insight into how the credit reporting agencies portray your firm to potential lenders. Remember that business credit uses different parameters than personal credit - the surest way to build business credit may be to make your payments on time, keep your information up to date, and keep your debt financing down.
When you review your credit reports, examine your:
— Company profile — Check details for accuracy: business name and age, address, phone, industry, number of employees and incorporation status. Much of this information is "self-reported," meaning the onus is on the business owner to ensure that the data is correct and up to date.
— Credit rating — Note if your rating is strong, average or poor. Reporting companies use different scoring methods, so their ratings might not be the same. For example, the D&B PAYDEX score ranges from 1 to 100, with higher scores indicating better payment performance; Equifax's Small Business Credit Risk Score operates on a scale of 101-992. If the report does not provide context for the score, consult the providers' websites for details on how to interpret your numbers.
— Payment history — Confirm that your payment history is accurate. Paying within the terms set by your suppliers may be the most direct way to drive a positive business credit rating. Look for trends that lenders might flag, like a change from paying in full each month to making minimum payments. — Ensure that all supplier relationships are represented. If you've been making timely payments to a supplier or lender, it should be reflected in your profile. If it is not, you will need to contact the vendor to report your payment history with them.
— Uniform Commercial Code (UCC) filings — This shows the liens and leases you have in place. View this information from a lender's eye: Is it accurate? Could your company be perceived as over-extended?
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