Why is Small Business Credit Important?
When considering the value and importance of a good credit rating to your business, you should think of credit as an asset. In the world of business, assets can be classified as tangible or intangible. Tangible business assets are physical assets that you purchase, such as a vehicle or office building. Intangible assets on the other hand are assets that aren’t quite as easy to see, or maybe even understand. These include copyrights, trademarks, and, the subject of this post, business credit.
Consequences of Poor Small Business Credit
Business credit is crucial for businesses that are seeking to increase their finance capacity. Creditworthiness plays in integral role in determining what kind of loans your business can receive. When a lender loans money, they are taking a risk. To reduce this risk they take many different factors into account to determine what exactly they can offer you. One of these factors is the business’s creditworthiness.
A poor or non-existent business credit history will lead to less opportunities for loans, increased interest rates, and decreased maximum funding amounts for your business. Without access to funds, businesses often won’t have the working capital and increased cash flow they need to survive. As such, it can’t be stressed enough how important it is for small businesses to establish a good credit rating. In fact, according to the Small Business Administration (SBA), the second most common reason for business failure is insufficient or delayed financing.
In this post, we’ll discuss how business credit is calculated, along with a number of methods that you can consider when looking to establish credit for your small business.
How is Business Credit Calculated?
Each major business credit bureau has its own method and formula for calculating business credit scores. As a general overview, some of the factors that they will look at include, but are not limited to, payment information gathered from banks and lenders, company size, length of time since you opened your first financial account, your current available credit limit, and various public records. It’s important to know how these different factors contribute to the way lenders view your business. If you’re not sure how you’d stack up, you can use a free online service to check.
How to Start Building Your Business Credit
Business credit does not simply happen after you start your business and take out a loan. There are quite a few steps that businesses have to go through in order to start building a credit history.
1. Incorporating your Small Business
This may seem self-explanatory, but it is the first step in establishing business credit. Sole proprietorships and general partnerships that are not incorporated are effectively the same as the owner under the law. This means they are not technically a “business” and they cannot have a credit rating separate from the owner’s personal credit rating.
In order to have a business credit rating, you’ll have to start separating personal and business finances. As a general guideline, the more separated your business and personal finances are, the better off you’ll be, and that doesn’t just mean for credit scores. Having distinct and separate business and personal finances will go a long way in keeping your business organized and, even more importantly, limiting your financial liability.
Forming a Limited Liability Company (LLC) or incorporating and setting up your business as a formal business entity is what will enable you to begin separating your personal and business finances from each other, and in turn allow you to start building a business credit rating separate from your own personal credit rating. You can continue to run your business as a sole proprietorship or partnership for as long as you like, but as long as you do you’ll be stuck with the credit profile that shows up on your personal file.
2. Obtain a Federal Tax Identification Number from the IRS
The employer identification number (EIN) is what the Internal Revenue Service uses to track businesses for the purpose of their payroll and taxes, and it is another step that has to be completed before you can start establishing a business credit rating.
Your employer identification number for your business is similar to how your social security number (SSN) functions for you as an individual. It will serve as an identification number for your taxes and a way for lenders to look up your credit and tax payment history.
Not all businesses are required to have an EIN as some are allowed to use only their owner’s social security number. However, they are easy to obtain and are an essential step to start building a good business credit profile. Whenever you apply for a loan, the lender will ask for either your social security number or your EIN. Having an EIN will allow you to rely on your business’s credit history to obtain a good loan with a favorable interest rate.
If you don’t already have an EIN for your business, you can apply for one through the IRS website.
3. Establish a Business-Specific Phone Line and Address
Establishing a business-specific phone line and address is important for a number of reasons. First, all business directories, including Yelp, Yellow Pages, Angie’s List, and, more importantly, the Better Business Bureau, require that you have a business address and phone number to sign up.
This is important because agencies that report business credit will often gather information from these sites to verify your business is still running. Additionally, make sure that your information is consistent across all platforms and that your phone number is set up with your business’s name.
Secondly, by setting up a phone line, you are establishing your first credit relationship. This will act as one of your first steps in establishing a good business credit rating, as your payment history will be reported to credit monitoring sites. Just remember to pay on time.
4. Open A Business-Specific Bank Account
Opening a bank account specific to your business will allow you to separate your business finances from your personal finances. In order to do this, you’ll need an EIN number, as described in the step above.
By doing this, you’ll be giving credit reporting agencies a bank reference. Since one of the factors that credit reporting agencies will consider is the length of time since your oldest financial account was opened, the sooner you open a business bank account the better.
Opening a bank account can also help you obtain better loans in the future, as many lenders will look for you to have an established business bank account before they will extend you a credit offer.
5. Open Business Credit Files and Apply to Dun & Bradstreet for a DUNS Number
Opening credit files is another one of the initial steps in creating your company’s credit profile. You should open a file with Experian, Equifax, and TransUnion. Make sure to check to confirm they haven’t already opened one for you without your knowledge, which is not unheard of on account of their data collection methods.
To see if your business is already listed, visit each site and enter your company information. Should your business already be listed, you should go ahead and order a business credit report. It will cost you money, but it is an important step in the process because you’ll need to confirm that all your information is accurate.
Additionally, opening a credit file with Dun & Bradstreet is an extremely important step in establishing good business credit. When you open a credit file with Dun & Bradstreet, you will be applying for a DUNS number, which is a nine-digit code that is unique to your business. As one of the best-known business credit reporting agencies, Dun & Bradstreet is used by many business creditors. Having a DUNS number will offer you more opportunities to apply for loans.
Need another reason to set up a D&B account? Federal government contracts and grants, along with Small Business Administration (SBA) Loans, all require you to have a DUNS number.
Applying is free and easy, however, the process can take up to 30 days.
6. Open a Business Credit Card Account
When it comes down to it, much of your business credit rating will reflect your business’s history of paying off debts. By opening a business credit card account and spending only what you know you can pay back each month, you can start building a good credit rating right away.
If you are unable to obtain a business credit card, consider applying for a secured business credit card. These are easier to obtain because you’ll be putting collateral down initially that will ensure that the lender will be able to recoup outstanding debt should you fail to repay it.
There are a lot of business credit card options out there, so make sure to do your research and find the one that will benefit your business the most.
7. Open a Business Line of Credit
Lines of credit are similar to credit card accounts in that you can borrow in increments, and then pay back based only on the amount withdrawn or used. There is a cap on how much you can borrow, and every time you repay your debt the cap is reset. They are an integral aspect of the operation of many small businesses, offering working capital whenever they need it. Just like a business credit card this will help you begin to build a solid business credit foundation.
That said, it is important to note that obtaining a business line of credit can be more challenging than obtaining a business credit card. Business lines of credit, especially long-term ones, often require your business to have been in operation with a good credit rating for multiple years. As a result, a line of credit may not be an option for start-ups. However, if you have been in business for some time and you are just getting around to starting to build business credit, a line of credit may be a good option for you.
8. Make Sure Your Lenders Report Your Progress
You’ve done all the work. You’ve set up your business to start building the great credit that you desire and you are being responsible and paying all your bills on time. However, your credit score isn’t improving. What could the reason be for this? Well, unfortunately, not all lenders report to the business credit bureaus. Therefore, it is important that you make sure the lenders you choose to borrow from report the necessary information. Or you can talk to your relationship manager to learn how and when your lender will report your information.
Most well-known banks and financing institutions do report to business credit bureaus. Many other finance companies will report to governmental authorities which the bureaus rely on for accurate data. However, if you are unsure, simply ask. You don’t want to spend years paying all your debts for it to have no impact on your credit score.
9. Keep Your Information Up to Date
While personal credit scores benefit from an efficient and relatively standardized model thanks to the FICO score, business credit unfortunately does not. In light of this, it is crucial you keep your information up to date and keep an eye on all four of the popular bureaus mentioned so far. These include Dun & Bradstreet, Equifax, Experian, and TransUnion.
Remember, a lender or some other financial institution could acquire your business credit report from any of the bureaus at any time, so it is important that you remain vigilant about keeping them up to date. While most of the information you are allowed to update is basic, data like the number of employees you have and certain financial documents can be important factors when lenders are trying to make a decision.
10. Repay Your Debts on Time and Be Financially Responsible
This is definitely very straightforward, but it is important nonetheless. Just like personal credit scores, business credit scores will suffer if you fail to pay your debts back on time and in line with the agreed upon terms and schedule.
The best way to ensure that you are meeting all your financial commitments is by being financially responsible. Don’t take on debts that you can’t afford to pay back or which you think you may have difficulty paying back. Also ensure that you fully understand any and all contracts you enter into with lenders so that you are not taken by surprise by unexpected fees and financial commitments. Overall, use your good judgement and common sense.
An Overview of Building Business Credit
Building a strong business credit profile is an important aspect of running a successful small company. Having a great credit rating can open up a world of new opportunities for your business by enabling you to have access to a wide range of loans and other financial opportunities. Through properly setting up your business to start building a credit score, you can ensure that you’ll be able to have access to these opportunities in the future when your business most needs them, whether that’s in a time of financial difficulty or when you are looking to grow your business and take it to the next level.
He has consulted some of the top brokerages, media companies and financial exchanges in the area of finance, online marketing and content management including: The New York Board of Trade, Chicago Board Options Exchange, International Business Times, Briefing.com, Bloomberg and Bridge Information Systems and 401kTV.
He continues to be a regular market analyst and writer for ForexTV.com. He holds a Series 3 and Series 34 CFTC registration and formerly was a Commodities Trading Advisor (CTA).He was also a licensed Property & Casualty; Life, Accident & Health Insurance Producer in New York State.
In addition to writing about the financial markets, Mr. Kelly writes extensively about small business marketing and finance.
Mr. Kelly attended Boston College where he studied English Literature and Economics, and also attended the University of Siena, Italy where he studied studio art.
Mr. Kelly has been a decades-long community volunteer, he established the community assistance foundation, Kelly's Heroes. He has also been a coach of Youth Lacrosse for over 10 years. Prior to volunteering in youth sports, Mr. Kelly was involved in the Inner City Scholarship program administered by the Archdiocese of New York.
Mr, Kelly was Sr. VP Global Marketing for Bridge Information Systems, the world’s second largest financial market data vendor. Prior to Bridge, Mr. Kelly was a team leader of Media at Bloomberg Financial Markets.
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