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The Business Credit Score: More Than Just a Number
Small business owners know the value of personal credit scores—they can be used to secure a loan, purchase property or cover unexpected costs. But it's also possible to cultivate a business credit score, which comes with its own share of benefits. Here's how.
What is a Business Credit Score?
Personal credit is typically measured using the FICO score, which was created by the Fair Issac Corporation. This score has a value ranging from 300 to 850, with higher values representing lower risk to lenders. Major credit reporting agencies such as Equifax, Experian and Transunion use FICO, but all have slightly different ways of calculating a score.
Business credit, meanwhile, follows a similar pattern—scores range from 0 to 100, with 75 or better considered 'excellent'. While a FICO model exists for businesses, the big credit reporting agencies each rely on their own, proprietary method. Yet scores are based on similar information, such as credit obligation to suppliers and lenders, any legal filings from court cases and public records of a business. Collections information also is considered to create a final value—and the lower a business score, the less likely a business can secure a loan or credit extension.
Obtaining a Business Credit Score
If you have not already chosen the legal entity for your business - e.g., corporation, limited liability company, partnership, limited partnership or sole proprietorship - you may wish to consult with your attorney and accountant to do so. Different legal entities have different characteristics in regard to personal liability of the principals involved, allocation of profits and losses, tax treatment of profits and losses, governance of day-to-day business operations, and other matters.
For example, it's a good idea to create a limited liability company (LLC) rather than a sole proprietorship, since with sole proprietorships it's possible for credit and personal scores to be listed on the same report. An LLC offers not only liability protection in the case of bankruptcy, but keeps all credit information separate. Apply at the IRS website for a federal tax identification number (FIN) for your business, also known as an employer identification number (EIN). Then, open a business checking account. Supply the information obtained from this process to all major credit reporting agencies.
What Impacts Business Scores?
Several factors impact a company's business credit score. First is the length of time the score has existed—the sooner loan applications are made and credit cards applied for, the better, since history plays a large role in risk evaluation. The total amount of credit extended to a business and the room remaining on any cards or lines of credit also are factors in determining a score. In addition, be wary of defaulted or late payments—these can have a significant impact on credit scores unless vendors or banks are notified ahead of time and agree to an alternative.
Make sure to regularly check with Equifax, Transunion and Experian to ensure scores are correct and relatively close in value. If one score is significantly higher or lower request a full credit report to determine if fraudulent transactions have been made or erroneous information supplied to credit reporting agencies.
Banks and Business Credit
Banks and other financial institutions look at business credit scores as the risk of default. The lower the score, the less likely they will be to extend loans for expansion or lines of credit for purchasing. Even if a small business encounters issues with credit applications, it's critical to never supplant business funds with personal credit, since this can cause an overlap in the two systems. And because business scores are queried much more frequently than personal scores, this also can cause degradation in personal rating over time.
Business credit scores are a necessity for long-term financial viability, and the sooner a credit score exists, the better for a business of any size.
To maximize a score, make sure to register with major credit reporting agencies, check regularly for any credit oddities and always make payments on time. In addition, keep personal and business scores separate to avoid artificial inflation or lowering.
Contact a Cadence Small Business banker to learn which business checking account is right for your business.