Your business credit is an indicator of your business’ financial health, stability, capacity to pay its debts, and attractiveness as a business partner.
What Is Business Credit?
Business credit is an assessment of your business’ ability to repay its loans and pay its debts. It is used by financial institutions and businesses to assess the financial condition of a business, its value, potential in its industry, the effectiveness of its management team, and desirability as a business partner. It significantly affects whether you will qualify for business loans, term loans, company credit cards, and favorable business contract terms.
Types Of Business Credit
There are three types of business credit.
Businesses can use credit cards, lines of credit, and loans to finance their operations.
Business credit cards are the most basic and common type of credit. For larger amounts of money they can use lines of credit which are like short- and mid-term loans. Business loans are the biggest source of funding. They can be worth millions of U.S. dollars and paid off over decades.
You Need Business Credit
Similar to your personal credit, your business credit is tracked by reporting agencies such as Dun & Bradstreet, Experian Commercial (Experian), and Equifax Small Business (Equifax). These credit bureaus report your business’ credit score to potential lenders, vendors, and business partners.
If you have a business, you will have a business credit score. When your business engages in financial transactions, your business partners, at least some of them, will report to the credit bureaus on how you paid your debts. Those reports can be requested by anyone and are used by financial institutions to make decisions about business financing.
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Your company credit is a part of your professional business image and is a key part of establishing your business as a legitimate, professional operation. If you do not develop, maintain, and carefully monitor your credit, you will find that despite any success you have in business, you will still be burdened with limited credit lines, high-interest rates, unfavorable business contracts, and your business may be significantly undervalued.
Moreover, if you seek to partner with other businesses or be acquired by another business, your credit score could become a substantial hurdle to overcome. It may even kill potentially lucrative business partnership opportunities for you.
Separate Your Business Credit and Personal Credit
While you are building your business credit, be sure to do everything you can to keep it separate from your personal credit. Your company credit has a different life, purpose, and value than your personal credit.
Let’s review the differences and similarities between business and personal credit.
Business Credit Score
Your business credit score is tied to your employer identification number (EIN). The EIN is the tax number used by the U.S. Internal Revenue Service (IRS) to identify your business and maintain its tax records. The credit reporting bureaus will report their estimation of your credit score to others using your EIN as your business’ unique identifier, like a person’s social security number.
A company credit score is an objective assessment of a business relative to other businesses in its industry. The score is based on a business’ reported payment history, lines of credit, and credit utilization. The score will also consider the length of time that your business has been in operation and number of employees.
Furthermore, a business’ specific industry must be considered. Some industries have highly leveraged, cash heavy, or seasonal companies. It is important to compare a business to others that are similar to it. In this way, it is assessed relative to companies that have the same financial and competitive stresses.
The credit score calculation also includes your bankruptcies, liens, judgments, and any other information that affects your business’ financial health.
The company credit score gives a comprehensive assessment of a business’ financial health at a glance. After reviewing the score, businesses can decide if they want to investigate your operation further, or just take action based on your credit score.
Business credit scores range from 1 to 100, with 100 being the best and highest possible score. For Experian and Equifax, the scores that rate a business’ payment history are called the Business Credit Score and Business Payment Score, respectively.
Personal Credit Score
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Your personal credit score is tied to your social security number (SSN). The IRS assigns each person an SSN, and their credit score is based on the reports companies send back to the credit bureaus about how they paid their bills, degree of credit utilization, and the amount of debt they are carrying on a revolving basis. This credit score is used to decide if private citizens will be approved for home loans, real estate loans, bank loans based on their personal credit, car loans, and any other financial endeavor that uses a person’s personal credit score (a.k.a. FICO) to determine if they are financially capable of paying their debts and repaying their loans.
FICO is based on whether you pay your bills on time (e.g., electric, gas, water, rent). Moreover, it also takes into account the bankruptcies, liens, court judgments, foreclosures, and charge offs linked to your SSN.
FICO scores range from 350 to 800, with 800 being a perfect score.
Business Credit Score vs Personal Credit Score
Despite their similarities, there are some notable differences between the 2 credit scores. These differences are significant, especially if you want to develop and maintain a great business credit score.
Challenging False Information
Personal Credit Report
Sometimes credit reports have incorrect information listed in them. If your report has false information in it that is adversely affecting your credit score, you’ll want to remove it. In this instance, private people can challenge any information listed in their credit reports and demand proof of the claim(s) made against them. By law, the company that has made the report must respond to the challenge. If the company fails to respond to the challenge, the credit bureau must remove the challenged information from the person’s credit report.
Business Credit Report
Business owners are at a disadvantage here. Companies are not required to respond to challenges to reported information on company credit reports. Since there are no legal consequences (to the reporting company) they are less likely to respond to requests for informational removal or proof of the claim against the business credit. This means that businesses must be diligent in monitoring their credit.
If incorrect information is found in the credit report, the business owners should immediately contact the company that filed the claim and get the information removed/corrected. This prevents false information reported to the credit bureaus from adversely affecting the business’ credit.
Transferring Your Credit Score
Transferring your credit score refers to your ability to assign your credit score to another party.
Personal Credit
Your personal credit score is yours only. It is linked to your SSN. You cannot legally sell your FICO. It is yours and intended to be an indicator of your financial ability to fulfill your financial obligations.
Business Credit
Your business credit is linked to your EIN. If you sell your business to someone else, your credit will be transferred to the buyer when the buyer becomes the owner of your business.
This is important because your business’ credit affects your relationships with other businesses and your ability to get favorable financial contracts, loans, and interest rates.
In short, the better your business credit, the more valuable your business is. The converse is also true. You could have a great business on paper, but the offer made to acquire it may be significantly lower than expected if your company credit score is low.
Potential Credit Capacity
Potential credit capacity refers to the amount of credit that may be available to you for financing your commercial endeavors.
Personal Credit
The potential credit capacity of private citizens using their SSNs to qualify for a credit line is about $30,000. Moreover, the credit terms tend to be short-term, except for home mortgages which can span decades.
Business Credit
Businesses have a greater potential credit capacity than private citizens. This greater credit capacity gives businesses a better chance to get the funding they need to expand their operations, hire more employees, and survive challenging economic times.
Benefits of Maintaining Your Business Credit
There are four primary benefits to maintaining good business credit.
Cheaper Credit
A high business credit score means better debt payment terms, lower interest rates on loans and credit cards, and longer periods of time allowed to pay your invoices. For example, a company with bad business credit may be required to prepay for their goods and services.
However, a company with excellent credit will be allowed to pay for its goods and services after they have been received and be able to do so over a period of 90 days or more at little to no interest.
Better Commercial Contracts
Vendors will perceive your business as one that offers more commercial opportunities and be a good long-term business partner if you have good credit.
Since businesses with good business credit are more likely to be sustainable, profitable, and continue their operations into the future, they are (potentially) great business partners in the present and far into the future.
No Personal Guarantees Required
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Often, businesses with no or poor business credit must have their financing personally guaranteed by the business owner. The personal guarantee ties the business owner’s personal credit to the business’ credit and performance of the business.
Ideally, you will want to keep your personal credit and business credit separate and not want to be required to personally guarantee your commercial deals. This is optimal for you as a business owner because you do not want your personal credit and assets to be tied to your business.
It is better if your business’ commercial dealings are limited to your business. If your business fails, goes bankrupt, etc., then the negative consequences will only affect your business.
Indicator of Good Financial Habits
Anyone reviewing your business’ good to great business credit will assume that it is that way because your business is managed well. Good credit is the result of paying your business debts, good financial planning, budgeting, and operating in a fiscally responsible and sustainable manner.
In short, a good business credit score is a sign that your business is run well, has a promising future, and is operated in a financially responsible way by an owner with good business acumen.
Building Your Business Credit
Take the following steps to build your business credit score and maintain it.
Incorporate your business
Set up your business as a limited liability company, S corporation, C corporation, or partnership. When you set your business as a separate entity from yourself, it has a more professional image and is more likely to be perceived as a legitimate business. All the information listed on your application to incorporate your business will be used by credit bureaus to report on your business’ operations (i.e., business credit score).
Give your business the most professional image possible
Here are a few tips to give your business the most professional image possible:
- Use a business address that is not the same as your personal residence.
- Have a business phone number that is separate from yours and can be listed with the business.
- Give your business a professional sounding name.
- Set up a professional email address for your business.
- Set up a professional web page or website for your business.
Hire a registered agent
If you live in the state where your business is incorporated, hire a registered agent. It is the job of the registered agent to receive all your correspondence, notify you of important paperwork and deadlines that you must meet to fulfill the state requirements applicable to operating your business, and receive service of process if you are sued in that state.
Request an EIN from the IRS
The IRS will assign your business an EIN for free. Make sure that all the information used to complete your application for the EIN is correct and the same as the information submitted to the state when you incorporated your business.
Open a business bank account
Your business and personal bank accounts should be kept separate, especially if you want to avoid an IRS audit. Your business bank will be one of the financial institutions reporting to credit bureaus about your company. So, review the options available and select a bank and account type that best fits the needs of your business.
Apply for a business credit card
Use the credit for business transactions and pay off the balance every month. This is another key way to build your business credit score. If possible, have at least 5 lines of credit (i.e., at least 5 different credit cards) for your business. Try to get the lowest interest possible, just in case you need to carry over your balance.
Request a DUNS number
A DUNS Number (a.k.a. D-U-N-S Number) is a nine-digit number used to identify your business, like a SSN is for you. The number is used by the business credit bureau Dun & Bradstreet. Dun & Bradstreet reports the credit scores of businesses around the world. Like the EIN, the DUNS Number is free. Just apply to the company and request one.
Credit Utilization
Never use more than 30% of your credit line. If you keep your credit usage at 30% or less, businesses will assume that your business is healthy, able to pay its bills, repay loans, and manage its finances well.
Pay your bills on time
Credit scores are built over time. It is easier to build a good credit score than to repair a bad one. So, do everything you can to pay your bills on time. Make sure that you monitor your credit with the credit bureaus, and have any false information on your credit reports removed or corrected (if possible).
Wrap Up
Take care of all the little things upfront so that you can focus on building your business, its credit, and establishing it as a legitimate, professional operation. You don’t have to do everything at the same time. Make a checklist and schedule for completing all the tasks, then follow it.
If you launch your business as a professional commercial enterprise, you will reap the benefits. Plus, you can avoid the headaches that many entrepreneurs and small business owners must deal with later on when they have to ‘fix ‘ things that they overlooked or did poorly.
Most importantly, get started and launch your business!