Business credit is an essential part of building a successful business. For anyone starting a business or running one, understanding business credit and why it matters can make a huge difference in reaching financial goals. Business credit is different from personal credit, and it’s essential for securing loans, managing cash flow, and expanding operations.
In this guide, we’ll break down the basics of business credit, explore why it’s crucial, and provide tips for building and maintaining strong credit for your business.
What Is Business Credit?
Business credit refers to the credit history associated with a business rather than an individual. It’s based on a company’s ability to pay its bills on time, handle debt, and demonstrate financial stability. Just like personal credit, business credit is tracked by credit bureaus, but it’s specifically for companies and helps lenders and vendors assess how reliable a business is financially.
When a business owner applies for financing, business credit plays a significant role in determining eligibility and terms. If a business has a high credit score, it’s more likely to get approved for loans with lower interest rates and better repayment terms.
How Business Credit Works
Business credit works similarly to personal credit. Every transaction a business makes that involves credit (like taking out loans, opening lines of credit, or even paying suppliers) is tracked by credit bureaus. This history then helps to form a business credit score.
Here’s a breakdown of how it typically works:
- Applying for Credit: When a business opens a line of credit or takes out a loan, that account gets added to its credit profile.
- Payment History: Regular, on-time payments build a positive credit history.
- Credit Utilization: Keeping balances low relative to credit limits is beneficial for maintaining a healthy score.
- Length of Credit History: Longer credit histories often mean a stronger credit score, showing that a business can manage credit over time.
When businesses maintain good credit practices, it signals to lenders and suppliers that they’re trustworthy and financially sound.
Why Business Credit Matters
Business credit is essential for various reasons. Whether you’re starting out or expanding, your business credit score can impact many parts of your operations.
1. Access to Funding
When you need money to grow your business, your credit score is a critical factor. A strong business credit score opens up more options, such as lower interest rates, better loan terms, and higher credit limits. This can make the difference between expanding quickly or staying stagnant.
For example, if you’re a business owner who wants to purchase new equipment, a solid credit score can help you secure financing with better terms, so you don’t have to drain your cash reserves.
2. Protecting Personal Credit
Business credit allows you to keep your personal credit separate from your business finances. Without a business credit score, some lenders may rely on your personal credit to approve loans, potentially impacting your personal credit score.
Maintaining separate credit profiles also helps in cases where your business faces challenges. Any financial struggles of the business won’t directly affect your personal credit score.
3. Better Vendor Relationships
A good business credit score can help you establish trust with vendors and suppliers. Vendors are more likely to extend favorable payment terms if they trust your business’s financial stability. This can improve your cash flow, allowing you more time to pay for inventory or supplies.
4. Lower Insurance Premiums
Some insurance companies look at business credit scores when determining premiums. If your business has a good credit score, it may be seen as a lower-risk client, which can lead to lower insurance costs.
5. Improving Your Business’s Reputation
A solid business credit score reflects a positive image to clients, vendors, and partners. It shows that you run a trustworthy, financially responsible business, which can open up opportunities for partnerships and collaborations that wouldn’t be available otherwise.
How Is Calculated?
Business credit scores are calculated differently than personal credit scores. While personal credit scores are typically between 300 and 850, business credit scores generally range from 0 to 100, with higher scores indicating better credit.
Major Business Credit Bureaus
Several business credit bureaus track and calculate business credit scores:
- Dun & Bradstreet (D&B): D&B offers the PAYDEX score, which ranges from 0 to 100. A score of 80 or higher is considered good.
- Experian Business: Experian’s business credit score ranges from 0 to 100, with higher scores reflecting better creditworthiness.
- Equifax Business: Equifax provides multiple business credit scores, such as the payment index score and business failure score, each with different scoring ranges and purposes.
Each bureau collects and evaluates information differently, so it’s common for businesses to have varying scores with different bureaus.
Building Business Credit: A Step-By-Step Guide
If your business is just starting, or you’ve never focused on building credit before, don’t worry—it’s never too late to start.
1. Set Up a Business Structure
The first step to building business credit is to ensure your business is structured in a way that separates it from personal finances. This generally means setting up a corporation or limited liability company (LLC).
2. Get an Employer Identification Number (EIN)
An EIN is like a Social Security number but for businesses. It’s issued by the IRS and used for tax purposes, as well as applying for business credit and opening a business bank account.
3. Open a Business Bank Account
Keeping your business finances separate from personal ones is essential. A business bank account not only makes accounting easier but also shows potential lenders that you’re serious about your business.
4. Establish Trade Lines with Vendors
One way to build credit is by establishing trade lines with suppliers or vendors. These companies can report your payments to business credit bureaus, helping build your score.
5. Use Business Credit Cards Wisely
A business credit card can help build credit if used responsibly. Keep balances low, pay on time, and avoid maxing out your credit limits. Over time, your on-time payments will positively impact your score.
6. Monitor Your Business Credit Score
Regularly checking your business credit score is essential for staying on top of your financial health. If you notice any errors, report them immediately to the relevant credit bureau to get them corrected.
Common Mistakes
Some business practices can hurt your business credit score, so it’s essential to avoid these mistakes.
Late or Missed Payments
Missing payments can quickly lower your business credit score. Ensure you’re paying bills on time, as even one late payment can negatively impact your score.
High Credit Utilization
Using a large portion of your credit limit can be seen as risky by lenders. Aim to keep your credit utilization ratio below 30% to maintain a healthy score.
Not Monitoring Your Credit
Failing to regularly check your business credit report can lead to issues if there are errors or fraudulent activities. It’s always a good idea to monitor your score and address any inaccuracies promptly.
How to Use Wisely
Having access to business credit is a powerful tool for growth, but it must be used wisely to avoid financial strain.
Plan for Repayment
Only take on debt that your business can realistically repay. Have a repayment plan in place and be cautious of overextending your business financially.
Reserve Credit for Growth and Emergencies
Credit should ideally be used to fund growth or manage unexpected expenses. Avoid using it to cover routine operational expenses unless absolutely necessary.
Build Relationships with Lenders and Vendors
Good relationships with lenders and vendors can be invaluable for maintaining strong credit. They may be more willing to offer flexible terms if they see you as a reliable and consistent client.
Frequently Asked Questions
Q: Can I start building business credit as a new business?
A: Yes, you can start building credit as soon as you establish your business structure, get an EIN, and open a business bank account.
Q: How long does it take to build business credit?
A: Building strong business credit can take time, usually a year or more, especially if you’re a new business. Consistent, on-time payments and responsible credit use are key to building credit over time.
Q: Is business credit separate from personal credit?
A: Yes, business credit is entirely separate from personal credit as long as you keep your finances separate and follow steps like setting up a corporation or LLC.
Conclusion
In the business world, credit is crucial for growth, stability, and credibility. Business credit matters reflection of your company’s financial health and can significantly impact your ability to secure funding, negotiate favorable terms, and improve cash flow. By understanding what business credit matters and following steps to build and maintain it, your business can benefit from greater financial opportunities.
Whether you’re just starting or looking to grow, managing your business credit matters responsibly will help your business thrive. With a strong credit score, you’ll be better positioned to handle unexpected expenses, invest in growth, and maintain the financial flexibility every successful business needs.