July 24, 2009

It is difficult to predict when your business will need to borrow, so it’s important to demonstrate responsible credit management long before funds are needed.  Lenders consider a variety of factors when evaluating your business credit, including both your personal and business payment and credit history. The following are some steps you can take to help ensure that you are prepared when the time comes.
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. Also important is using borrowed funds for the right purpose, such as covering a temporary cash flow shortage or financing growth. In these cases, the funds for repaying the debt should be clearly identifiable and could justify the risk of borrowing.

Use the right financial tools for the job.

Managing your credit is easier when you understand the intended purpose of various financing tools. You can 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.

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.

For more costly purchases such as capital equipment or real estate, a traditional loan, with its fixed payment schedule, might be most appropriate.

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.

When lenders assess a company’s creditworthiness, they often use criteria called the “5 C’s”:

• Character — What is your company’s credit history? How likely are you to repay the loan?
• Capacity — Is your company’s cash flow sufficient to meet current and prospective loan or lease commitments?
  
• Collateral — What non-cash business assets, such as equipment, real estate and inventory, can be used to secure a loan?
  
• Capital — What’s your personal net worth, or the net worth of your business?
  
• Conditions — What outside factors such as economic conditions, competition and the like may affect repayment?
  

Minimize bad credit risks.

Take steps to protect yourself from the “wrong” kind of business associate by checking references on prospective partners, customers and vendors. Encourage on-time payments by sending customers 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.

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 can help your company establish a credit history as well as 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.

Maintaining a high business credit score requires ongoing attention. Smart companies actively manage credit ranking as part of regular financial management. Read “Understanding Your Business Credit Report” and/or download this OPEN Book guide and worksheet to help determine how successfully you are managing your company’s credit and where you might begin to make improvements.