Building and Protecting Business Credit

Responsible credit management is essential to small business success. It can help your business get the money it needs when it needs it and at a good rate. Strong credit can also help your company close deals since many companies now check credit on vendors before agreeing to a contract.

It is difficult to predict when your business will need to borrow, so savvy businesses work toward demonstrating responsible credit management long before funds are needed. Here are some steps you can take to help ensure that your credit profile prepares you for borrowing.

Demonstrate good debt management skills

In order to build a credit history you need to use credit. Look for an opportunity to borrow money at a time when your business can use the funds responsibly and pay them back quickly. These good borrowing habits and proven ability to repay can help provide a solid foundation for future borrowing.

A key part of successful debt management is using borrowed funds for the right purpose. Good reasons to borrow include covering a temporary cash flow shortage and financing growth. In these cases the funds for repaying the debt should be clearly identifiable and could well justify the risk of borrowing. Less ideal is taking on debt to dig out of a financial crisis or to fund payroll. In these cases, unless you have funds earmarked to repay the loan, taking on debt can be risky.

Use the right financial tools for the job

Managing your credit is easier when you understand the intended purpose of various financing tools. Use the following list as a guide.

• Use charge cards when you can pay off purchases in full by the end of the month so you don't have to pay for access to the capital, e.g. interest.
• If you want to carry a charge over several months, consider using a credit vehicle that lets you pay off interest but keep a revolving balance.
• A business line of credit can help you smooth cash flow, make seasonal purchases or manage short-term cash crunches. Be careful, though, about using it for long-term debt.
• For more costly purchases such as capital equipment or real estate, a traditional loan, with its fixed payment schedule, might be most appropriate.
• Use business credit cards for as many purchases as possible. Although you may pay a fee for the card, the purchases you can make with accrued points will likely offset any usage costs.

Understand lenders' guidelines

Like you, lenders want to minimize risk. They often use criteria called the "5 C's" to assess a company’s creditworthiness. Consider how your company performs in these areas to help put you in the best light when applying for financing:

• Character: What is your company's credit history? How likely are you to repay the loan?
• Capacity: Is your company's cash flow sufficient to meet current and prospective loan or lease commitments?
• Collateral: What non-cash business assets, such as equipment, real estate and inventory, can be used to secure a loan?
• Capital: What's your personal net worth, or the net worth of your business?
• Conditions: What outside factors such as economic conditions, competition and the like may affect repayment?

Minimize bad credit risks

Slow-paying customers can impact your ability to access capital. Irresponsible vendors can have a similar impact. Take steps to protect yourself from the "wrong" kind of business associate by checking references on prospective partners, customers and vendors. Stay on top of your customers to encourage on time payments by sending notices when a receivable is due or late. Consider accepting credit cards, which can both lower your exposure to late payments and increase the timeliness of your receipts. Credit card companies can also act as intermediaries should a dispute arise, and potentially assist you with fraudulent charges.

Separate business and personal credit

While many business owners find their personal and corporate finances linked, it is important to keep these as separate as possible. Avoid comingling business and personal assets. Set up business savings and checking accounts. Have a dedicated business charge card account, as well as separate business loans and credit lines. Separation has two major benefits – it helps your company establish a credit history, and it can reduce the impact that a business problem can have on your personal credit. Be aware, however, that many lenders will closely examine the personal credit history of a company's owners before approving financing.

Published under agreement with OPEN Small Business Group.