While most small business owners are well aware of personal credit scores (like those from FICO), the concept of business credit remains more elusive. Though 65 percent of business ownersuse credit for business purchases, only 50 percent of those cards are in the business’ name. This article tackles the basics of:
- What business credit is
- What affects business credit scores
- How to establish a business credit profile
- Ways to maintain a good credit score
The Basics of Building Business Credit
For many people, discussing credit or credit cards has become a social taboo. In a study by Experian, the average American’s credit card debt has creeped up 3 percent from last year. The good news is despite the rising debt, credit scores have also increased.
The reality is you need credit to purchase a home, a car, and to sometimes to get business credit. The best way to wrangle this beast is to increase your financial literacy on how credit works, and to get an in-depth knowledge on the ways personal credit differs from business credit.
For small business owners, keeping their personal credit in good standing and separate from their business ventures is crucial. Though, it’s still something that not many people fully understand. Let’s dive into how a business owner establishes a business credit.
What is Business Credit?
Business credit is the result of the information collected by business credit bureaus. They look into your business trade credit transactions in order to create your business credit report. They use your business name, address, and federal tax identification (FIN), otherwise known as your employer identification number (EIN).
Based on your company’s business credit transactions, the business credit bureaus will compile the data and create a report that determines your business’ credit profile. This affects the amount of money your business can be granted, the types of credit cards you can open, and whether or not your business is deemed financially trustworthy.
Establishing Business Credit Profile
Before the major credit bureaus Dun & Bradstreet, Experian Business, and Equifax Business can begin compiling the data necessary to provide a credit report, you need to incorporate your small business. With sole proprietorships and general partnerships, the business is legally considered the same as the owner. Incorporating a business or forming an LLC creates a separation from the individual, this provides protection to the owner’s personal assets.
Dun & Bradstreet uses a 9-digit DUNS (Data Universal Numbering System) number to identify every business that has a credit file. The Small Business Administration reports the DUNS code is “the most widely used number for identifying companies in the United States.”
With personal credit, your history is automatically tracked; however, if you have a small business, you or your vendors have to voluntarily send your information to business credit bureaus in order for it to be reviewed. Your business needs to have a federal tax identification number or employer identification number (EIN). The process for obtaining this is fairly easy. Go to the IRS websiteto access the EIN Assistant page, and click on “Begin Application” at the bottom to get started. The EIN is required on federal tax filings and to open a business bank account in the name of the corporation or LLC. The EIN is like your small business’ social security number.
The next step would be to open a business credit profile with all three of the major credit bureaus in order to have your information tracked. Each credit bureau calculates business scores differently, so it’s important to note their range and how they rank high credit risks compared to low credit risks.
Factors that Determine Your Credit Score
Business owners are responsible for opening their business credit profiles to establish business credit. Once a credit profile is open business credit card issuers may need to be notified to report credit transactions specifically to business credit reporting agencies. The Experian and D&B credit scoring system uses a range from 0-100; the higher the number, the lower the risk. Equifax’s scoring system ranges from 101 to 816. The primary determining factors of a business’s credit report can be:
- Number of trade experiences
- Outstanding balances
- Payment habits
- Credit utilization
- Trends over time
- Public record recency, frequency, and dollar amount
- Demographics such as years on file, Standard Industrial Classification codes and business size
- Delinquencies such as collections, bankruptcy, and liens
Building Your Business Credit Score
In order to begin sending positive activity to the business credit bureaus you should be conscious of keeping your credit utilization low, and managing a variety of credit. Begin by opening a business checking and savings account, apply for small business credit cards in your company’s name, and obtain a small business loan using your business savings account as collateral.
Once you’ve created a business credit profile it’s important to maintain exemplary financial behavior. The goal is to be considered a low risk to banks and other financial institutions. This is accomplished by paying your bills on time and in-full by the end of each month.
Business credit is an intangible asset, according to the NSBA Small Business Access to Capital study. 20 percent of small business loans are denied due to business credit. Of businesses surveyed, 27 percent claimed that they were not able to receive the funding they needed. For those 1-in-4 businesses, the most frequent effect the lack of funding caused was preventing the owners from growing their businesses.
As a small business owner, it is imperative to begin building your business credit profile to maximize your company’s funding potential. Stay informed and up to date with your credit reports, and your business will become a trustworthy borrower.
Guest post: About the Author
Courteney Reed, is a financial industry analyst dedicated to empowering people to make smarter financial decisions.