Small businesses play no small role in the U.S. economy. According to the U.S. Small Business Administration (SBA), there are 29.6 million small businesses in the United States, which account for 99.9% of all the nation’s businesses.
Small businesses clearly make up the backbone of the US economy. However, many small business owners remain perplexed by the concept of business credit and how it works. More often than not, small business owners take on personal loans and use personal credit cards to fund their businesses, which can lead to financial and organizational headaches. This article aims to do three things:
- Help small business owners understand the elusive concept of business credit
- Highlight the factors that affect business credit scores
- Assist them in building business credit
What Is Business Credit?
Business credit is a line of credit offered to a business that the business can use to pay unexpected expenses, or expected operating expenses when there is a lack of available cash.
Your business credit scoresare represented by numbers that signify whether your business is suitable for loaning money to or doing business with.
There are three primary credit bureaus (Experian, Dun & Bradstreet, and Equifax) that uniquely calculate business credit scores. Each has a different scoring algorithm. Experian and Dun & Bradstreet’s credit scores both range from 0 to 100, while the Equifax scoring scale ranges from 101 to 816.
Similarly to personal credit, those issuing credit to you will rely on your business credit scores in their decision making. The higher your business’ credit scores, the more likely you’ll be able to secure larger credit limits as well as more rewards and benefits.
What Factors Affect Business Credit Scores?
While your business credit scores vary depending on the specific credit bureau’s algorithm, a few general factors that underlie these scores are:
- Number of trade experiences
- Outstanding balances
- Payment habits
- Trends over time
- Public record frequency and dollar amount
- Delinquencies such as liens or bankruptcy
- Credit utilization (the percentage of your total business credit that is being used)
- Demographics such as years on file, Standard Industrial Classification codes and business size
5 Tips To Build Business Credit
Creating business credit is not something that happens automatically. It requires multiple steps on the part of the business owner. Building business credit will not only benefit the business’ credit scores, but open more credit card and loan options for the business. These funds allow the business to keep growing.
In the instance that you have never incorporated your business, or you are starting a small business from scratch, this quick guide will direct you down the path of building your business credit.
1. Incorporate Your Business
The first step on the road to building business credit is to separate yourself from your business through incorporation. Through incorporation, your business will become a distinct legal entity from your person. The U.S. Small Business Administration provides an in-depth guide to launching your business, including incorporation, which would be recommended for all budding entrepreneurs and small business owners.
2. Obtain an Employer Identification Number (EIN) from the IRS
An EIN identifies your business for credit and tax purposes. It’s essential to get an EIN number for an SBA loan. In most cases, it is necessary to have one to open business bank accounts. An EIN allows business owners to separate their social security numbers from their businesses’ credit profiles.
3. Register with Dun & Bradstreet
When a business applies for business credit, lenders and suppliers commonly perform a credit check through Dun & Bradstreet. Register and set up a company profile under Dun & Bradstreet’s database in order to start establishing credit. Dun & Bradstreet will issue a nine-digit DUNS number that is universally used to identify businesses.
4. Open a Checking and Savings Account for Your Business
Open both a checking and savings account in your business’ name. This is done using your recently provided EIN and DUNS numbers. By doing this, you’ll separate your personal and business finances.
A business savings account is not mandatory, but is an intelligent move for any small business owner. A business savings account can assist when an unexpected cost arises and it can also be used as security for taking out a small business loan.
5. Obtain a Business Credit Card & Responsibly Manage Your Finances
Business credit cards are key to building business credit. It’s recommended that these credit cards should be commercial in nature and used for business expenses. Business owners should put any business credit accounts in the name of the business using their EIN and DUNS numbers.
It should be noted that not all business credit cards are created equal. Different business cards provide different types of rewards and benefits. Business owners should do their research and find business credit cards that aligns with the goals of their businesses.
While obvious, it is imperative to maintain excellent financial behavior to build business credit. Make sure to keep your credit card utilization low, pay all bills on time and in-full, and use a variety of credit.
Building strong business credit is not something that’s automatic or instantaneous. It requires business owners to be proactive and behave with financial responsibility. Time and excellent financial behavior are necessary ingredients in establishing high business credit scores for your small business. By understanding the core business credit concepts and following these tips, your business credit scores should be flourishing in no time.
Guest Post: About the Author
Courteney Reed is dedicated to empowering people to make smart financial decisions. As a financial industry analyst, she is driven to provide the most current and highest quality information available.