By Brian Manson, Credit Manager at Balboa Capital
Nothing is more important to the health of a business than having access to credit. At some point most businesses need credit, whether it is to purchase new equipment or fund expansion projects. It is critical to understand how to build and maintain business credit because the strength of your business credit directly impacts whether future lenders will have the confidence to lend money to you.
In such a dynamic business environment, it is difficult to determine when your business will need to borrow.
You should begin building a good business credit profile so that your business is in the best position to obtain credit when the need arises.
Your Business Credit Profile
Similar to a personal credit report, a business credit profile is an unbiased representation of how a business manages its financial obligations. The major business credit bureaus generate your credit profile. Personal information, such as a social security number, is not used to establish a business credit profile. Instead, credit bureaus use your business name, address and a Federal Tax Identification number (FIN), or Employee Identification Number (EIN), to create a profile completely separate from your personal credit history. Your business credit profile contains information that is both self-reported and reported by third parties, which include your creditors and lenders.
The following is the type of information reported on your profile:
Company Background: business name and time in business, address, phone, industry, number of employees, annual sales, incorporation status, etc.
Trade payment and banking data
Public records: suits, liens and judgments, UCC’s, business registrations and bankruptcy filings
Corporate financial reports
Credit investigations and interviews conducted by credit bureaus
Business creditors are not required to report trade credit transactions to credit reporting agencies. To ensure you do not miss an opportunity to build your profile, ask vendors who are issuing credit to you if they will report your company’s business transactions to credit bureaus. Your business credit profile is what lenders review to determine your credit-worthiness and the risk of extending funds to you, so it is important that your trade credit history is included in your profile.
Steps To Establish Business Credit
Whether you are starting a new company or are already operating a business, there are basic steps to establishing a business credit profile.
1. Choose Your Corporate Structure.
Corporations and Limited Liability Corporations (LLC) provide enable business owners to build business credit completely separate from personal credit. However, corporations face double taxation – once at the entity level and again through the shareholders – whereas, LLC’s are only taxed through shareholders on dividends paid to them. Forming your business under a sole proprietorship or partnership incorporates your personal credit into your business credit, leaving you personally liable for your business debt. Here, business owners are only taxed on their share of profits, similar to the tax structure for LLC’s. It is important to carefully determine which corporate structure works best for your business and credit needs.
2. Apply for an Employer Identification Number.
To identify your business as a separate entity, you must apply for an Employer Identification Number (EIN), also known as a Federal Tax Identification Number (FIN), with the IRS. This number is a unique identifier used to file corporate taxes and to determine if your business is in good standing with the state in which you are incorporated. To obtain an EIN number, submit Form SS-4 to the IRS.
3. Meet Business Credit Market Requirements.
Fulfilling business credit market requirements puts your business in a better position for credit approval. Requirements are as basic as having a phone line and a business license. However, not complying with them can be very detrimental to your credit-worthiness.
4. Register Your Company With Credit Bureaus.
Be sure to register your company with the major business reporting agencies, which include Dun & Bradstreet, Experian Business, and Equifax Business. When you register with Dun & Bradstreet your business is given a DNB (DUNS) number (a unique business identifier) and a password so that you can review your credit profile. You will go through the same process with the other two bureaus. To complete your credit profile with each of the credit bureaus you will need your incorporation documents and EIN number.
5. Review Credit Profile.
Once you are registered with the major business credit bureaus, it is important that you pull your initial credit profile to review your company information and update any missing or incorrect data. Before you try to apply for business credit, your profile should be polished, accurate and complete.
6. Obtain Business Credit.
You have taken all the steps to now open accounts under your business name. Begin with applying for small credit lines with your vendors. Remember to apply using your EIN number instead of your personal information to ensure you are establishing and reporting a business credit.
Once you’ve established payment history with your open business credit lines, credit bureaus are able to review your history and rate your payment performance.
Business Paydex Score
As consumers, we understand the importance of a good personal credit score. As a business, it is just as important to maintain a strong business credit rating. Many business lenders use your business’s Paydex score to help determine whether credit should be extended to your business.
Your Paydex score is the business equivalent to a personal FICO score. Specifically, it is Dun & Bradstreet’s unique dollar-weighted numerical indicator of how a firm paid its bills over the past year, based on trade experiences report to D & B by various vendors.
Just as a FICO shows an individual’s ability to repay debt, a business Paydex score indicates a company’s debt payment performance. However, unlike a FICO score which takes into account several factors, a business Paydex score is based on one factor. It is calculated solely on how timely your payments are to creditors during the term of payment.
Paydex score ranges from 0 to 100 with higher scores indicating better payment patterns
Paydex score of 80 represents payment within agreed upon terms and is a favorable score
Most lenders will consider Paydex scores of 70 or higher
Your Paydex score directly impacts a lender’s evaluation of your business’s credit-worthiness and ability to pay back debt. Therefore, it is important to keep a favorable business credit score and take steps to improve it. The best way to raise your Paydex score is to pay your bills as early as possible, since your score is directly correlated to how timely you repay debt. To raise your score above 80, you must pay ahead of the agreed upon terms. It is also important to keep business credit lines active. Similar to personal credit, ongoing credit activity will help sustain a higher Paydex score.
How to Maintain A Good Credit Profile
Once you’ve established your business credit, it’s critical to keep your credit profile in the best shape as possible. Remember, your business credit profile is what portrays your credit-worthiness to potential lenders. Luckily there are simple ways to maintain a strong business credit profile.
Make timely payments – Be sure you are paying within the agreed upon terms you have set with your creditors. Your payment history has the most powerful impact on your credit profile and credit score.
Monitor your credit profile regularly – Review your business profile periodically to spot and address any inaccuracies. Confirm that your payment performance is accurate and be sure to remove any accounts that are falsely reported. You should also make sure that all trade activities and relationships are represented. If you have been making prompt payments to a vendor and it is not reported, contact that vendor to ensure the account gets included in your profile.
Keep your debt financing down – The more your company borrows to run your business, the higher the risk to the lender and more difficult it is for you to secure credit. Therefore, it is important to be selective about the debt you incur and to keep your debt financing low.
Manage your personal credit responsibly – Although your personal and business credit are completely separate, depending on the lender, your personal credit history may be reviewed to help determine your company’s borrowing potential.
Your business credit plays a very critical role in the success of your company. How you manage your business credit profile strongly impacts your company’s borrowing potential. Managing your profile responsibly makes it easier to get approved for funds and gives you the opportunity to invest in the growth of your business.
Brian Manson, Credit Manager at Balboa Capital, has more than 20 years of credit industry experience. Throughout his professional career, Manson has specialized in equipment financing for small businesses, middle market companies, large corporations and equipment vendors throughout the United States.