Building business credit can seem a daunting task. Fear not: there is a method to the madness. The key is in understanding what credit reporting agencies, lenders and other businesses look for when evaluating creditworthiness. Once the most important factors are identified, developing and implementing a strategy to address them and improve business credit is a relatively easy process.
The benefits of building business credit are extensive. Among them, the ability to acquire credit and financing on favorable terms and when it’s most needed is perhaps the most important. Having that capacity can help businesses navigate constrained cash flow, paying for large purchases, business expansion and more.
Read on to discover what credit reporting agencies look at when determining your business’s creditworthiness.
5 Factors That Influence Business Credit Ratings
- Business Structure – The legal structure of your business can impact creditworthiness in the eyes of lenders. For example, sole proprietorships are often viewed as significantly riskier ventures than are corporations or LLCs—potentially reducing lenders’ willingness to extend credit and favorable rates to the former.
- Type of Business – Some types of business are inherently riskier than others, depending on the industry they are in. Recent boom and bust industries like Internet start-ups may be subject to higher interest rates or lower credit limits, while others that have proven to be in high demand and experiencing steady growth can often receive more advantageous terms.
- Length of Time in Business – We’re all familiar with the adage that “most businesses fail in the first 2 years.” While that’s not exactly the case (according to the Small Business Administration, most businesses fail within the first 5 years), the initial phases of a company are some of the most precarious. That leads creditors more amenable to negotiating with established businesses that have demonstrated their longevity.
- Debt to Income Ratio – If cash flow were not an issue, many businesses would not apply for financing in the first place. Lenders certainly understand this, but at the same time, they want to mitigate the possibility of default by only extending financing to companies that are likely to pay them back. If a business is already burdened with debts that they are unable to pay off, it may be cause for concern.
- Payment History – Last, but not least, late and nonpayment records can have drastic negative effects on business credit scores. Delinquent payments signal unreliability and risk. Conversely, a track record of on-time payments made in full signal liquidity and responsibility—increasing lenders’ willingness to grant financing and on better terms.
Improving Business Credit Scores
Aside from the length of time doing business, these are all factors that can be easily addressed. For example, picking an appropriate legal structure with the right tax and financing advantages can be done even after one has already been adopted. Transitioning from sole proprietorship to LLC or corporation is not an uncommon occurrence.
Even the impact of a riskier type of business can be to some extent mitigated by choosing the industry codes that most favorably represent your enterprise on financing applications.
Equipped with just some basic knowledge, the process of building business credit becomes much more transparent and achievable. Applying that knowledge is all that remains.
[Photo Credit: Dougsloan2010]