There’s a saying that you have to spend money to make money. If you’re a business owner, you probably know that having the support of outside capital might mean the difference between keeping the lights on or having to shut your business down. Much like with your personal credit score, your business credit score can determine your eligibility for business lines of credit and business loans, among other things.
What you may be surprised to find out is that your business credit score is calculated in a completely different way than your personal credit score. This is because credit reporting for your business goes through different agencies to those that track personal credit. So, it’s possible to have a great credit score for your personal report, but no credit score for your business.
Why is business credit important?
A strong business credit report is a sign that your business handles credit and debt responsibly. It is a way that lenders ensure that if your business requests funds, the business will be able to repay them. The stronger your business credit, the more safeguards you give your business in terms of access to loans and lines of credit. And a high business credit score may qualify you for a business loan or credit without a personal guarantee. Strong business credit also increases your business’ eligibility for lower interest rates and insurance premiums, offering potential savings on borrowed funds. Not to mention, a high score can make it easier for your business to get approved for rental space and get better terms from vendors.
Your business credit is an indicator of a variety of important factors. For starters, it is a signal of the financial stability of your business. It can also be used to predict delinquency, credit risk, and financial stress within the business. Vendors can use information in your business credit report to predict the likelihood of timely payment.
Your business credit report also documents important information about your business such as your tax ID, number of employees, annual sales volume, business age, and trade payments.
Why should you separate business credit and personal credit?
Keeping your business finances and your personal finances separate is important for the health of both. Often for businesses that are just starting out, a personal credit score is used to determine creditworthiness. However, as you establish reporting on the financial behaviors of your business, your business credit score will become the primary factor used by most lenders. Having a separation between your business credit and your personal credit is important for a variety of reasons. For starters, a business credit score looks at fewer factors than your personal credit score. A business credit report mainly collects data on payment history. In contrast, a personal credit report analyzes payment history, credit history, credit utilization, and other factors. Using your personal credit score can make it more complicated to get approval for funds for your business.
Another consideration when dealing with businesses finances is taxes. If you are planning on deducting business expenses when you file your taxes, it is imperative that you keep your business finances and personal finances separate. Keeping your personal finances separate from your business finances also makes sure that your personal finances can’t be leveraged for business debt.
Because the business credit scores and personal credit scores are reported by different agencies, keeping them separate also helps to avoid confusion. Vendors and lenders can look at your business credit score to get insight into your ability to handle funds instead of trying to comb through your personal credit report. It also means you won’t have to worry about a hard inquiry into your personal credit report each time your business needs to apply for funds.
How do you build business credit?
Building strong business credit starts by understanding how information about your business finances is collected and reported. There are several business credit bureaus that collect data and create reports on businesses. You don’t have to keep up with all of them, but it’s good to know three of the major ones: Equifax Small Business, Experian Business, and Dun & Bradstreet. Each credit bureau handles data collection and reporting on businesses differently. However, there are some general pieces of information they collect, such as payment history, banking practices, bankruptcy filings, and public records information.
Business credit bureaus use the information they collect to create a variety of scores. They will create a general business credit score, but may also create a delinquency score and a business credit risk score. Each agency uses a different scale to calculate scores. Equifax assigns scores from 101-992, with 992 being the strongest. Experian uses the Intelliscore Plus model, assigning scores from 0 to 100, 100 being the best. Dun & Bradstreet assigns a Paydex score using a scale of 1-100, 100 being the strongest.
Building business credit takes time, and many credit bureaus don’t automatically generate reports for your business. For some reporting agencies you have to register to get a number to have them collect data on your business. For example, Dun & Bradstreet requires you to have a D-U-N-S number. Equifax, on the other hand, decides when it begins reporting on a business, you can’t request it. Unlike personal credit reports, you don’t have a legal right to a business credit report. This means that you have to lay the groundwork in order to get the credit bureaus to add you to their reporting. Keep reading for some of the steps you can take to do so.
Establish a business identity
Building strong business credit, and a strong business in general, starts with having a clear business identity. When you’re first getting started with your business, it may be easier to begin as a sole proprietorship. However, it’s a good idea to move your business to a separate legal status as soon as possible. Establish a legal business name for your business. Get a dedicated phone number that you only use for business purposes. Open a bank account for your business. These steps help to establish your business has its own entity and give you the tools to start building relationships with suppliers and vendors. Once your business has an identity separate from yours, it can begin to build credit separate from your personal credit.
Register for an EIN
An Employer Identification Number (EIN) means you are identified as a business entity by the IRS. This formal identification is one more step in legitimizing your business as its own entity. It can also give you an advantage when applying for business accounts, credit and loans. Not to mention, an EIN helps you to file taxes for your business and avoid tax penalties. This number can also be used by business credit bureaus to easily identify your business during data collection and reporting. You can get an EIN for free through the IRS website.
Incorporation, or establishing an LLC (limited liability company), is another way to formalize your business. This step also affords you some important personal protections. When you formalize your business, you legally separate your personal and business identities. This separation means that your business credit will be able to develop as a separate score from your personal credit. It also means that your business finances will be separated from your personal finances.
Apply for a business credit card
A business credit card will give you a way to build your business credit score. In order to build business credit, you need to have the finances of your business reported. One way to do that is getting a business credit card. A business credit card is also very helpful in keeping personal expenses and business expenses separate. You can also use your monthly statements from your business credit card to help with your recordkeeping. Business credit cards can be used to cover a variety of expenses, especially when cash flow is unstable. Not to mention, many business credit cards have rewards structures that can boost your business finances.
Maintain good payment habits
Your payment history with lenders, vendors, and suppliers is a big part of how your business creditworthiness is determined. Ensuring you make early or on-time payments is important for a strong business credit score and for maintaining good business relationships. When you miss payments, it can cause a domino effect of financial issues for your business. Legal filings against your business and liens are public record this data is collected by business credit bureaus. To make sure that your business credit report stays strong, you’ll need to have a clear repayment structure for any debt your business accumulates.
Foster strong relationships with vendors
Your relationships with the vendors that you work with are important to the health of your business and your business credit score. When you make timely payments with vendors and keep stable accounts, you’ll be adding to your business’ payment history. And if you’re making early payments, you’ll see your score increase faster. Keeping your accounts current will also help to keep your delinquency and financial risk scores low. However, it’s important to make sure that vendors are reporting your interactions to the business credit bureaus. If not, you won’t see your score improve. Data from multiple vendors is often needed for business credit bureaus to generate a report. When working to build your score, ask for small lines of credit and pay them off promptly.
What is a business line of credit?
A business line of credit is a cash flow resource that provides funds to help support business financial needs. Much like a personal line of credit, a business line of credit allows you to borrow money up to a certain limit. Unlike a business loan, a business line of credit allows access to the funds you need as you need them, up until you reach your credit limit. When you pull funds from your business line of credit, you pay interest only on the amount that you borrow. As long as you are consistent about repayment and don’t exceed your credit limit, your business line of credit can serve as a financial support for your business expenses.
To be able to apply for a business line of credit, your business will need to have been up and running for at least a year. Potential lenders will likely request certain documents that give insight into your business financials. You’ll want to have business tax returns, banking account information, and registration documents available in order to qualify. Your lender may also request your personal bank and tax information.
Once you’ve applied, lenders will take a look at your business credit report in order to determine whether your business should be approved. Your business credit score, annual revenue and the length of time your business has been in operation are all factors used to help with this determination. These factors also come into play when lenders determine the amount of your credit limit.
A business line of credit is available from banks, credit unions, and even some online lenders. When deciding where to apply for a business line of credit, take some time to compare terms, fees, and interest rates. Also, keep in mind that larger lines of credit will often request some form of collateral as a guarantee against any missed payments.
Interest rates for a business line of credit are usually lower than those for business credit cards. However, you will need a strong business credit report to qualify for the best rates. Online lenders give more leeway than banks, but will often have lower credit limits and higher interest rates.