Business Credit: How to Get It, Build and Keep It
Knowing What a Lender Looks for in a Borrower Is Key
BY DOUG ROZSA
Special to the Business Journal
For every business, establishing good credit is an important and ongoing financial priority.
At some point in its business cycle, owners will need financing for a number of needs, such as seasonal working capital loans, financing accounts receivable, restocking inventory, capital equipment investments, taking advantage of trade discounts, paying for office supplies, emergency repairs, taxes and assessments.
Today’s business owners can tap into a variety of loans and lines of credit. For example:
& #149; Lines of credit offer fast and flexible funds to meet short-term cash requirements.
& #149; Long-term loans give businesses the funds needed to acquire fixed assets, such as equipment or commercial vehicles, to make leasehold or capital improvements, to finance long-term sales growth or to expand their product lines.
& #149; Short-term loans help businesses pay for specific needs, such as financing the operating costs of a single large contract.
& #149; Unsecured business credit cards help businesses fund a variety of expenses, including operating expenses, seasonal purchases and property improvements.
& #149; Secured business credit cards help new business owners establish a credit record, access a convenient widely-accepted method of payment and put cards in the hands of employees.
But credit is typically available to businesses that have invested in building a good credit history. To receive the credit that your business needs, it helps to know what a lender looks for in a borrower. The more you know, the more likely you are to get your credit request approved.
– The Five C’s Of Credit
Before any financial institution extends credit, it wants to be confident of being repaid. Typically, lenders ask the “Five C’s of Credit” questions, which help them develop a profile of applicants. Your answers to these questions will help a lender determine whether to extend credit to you.
& #149; Character. What kind of borrower will you be? A lender’s best clue to your character is your personal credit history. Chances are, it will check to see how well you’ve managed your personal debt in the past. Do you pay your credit card bills on time? Your mortgage payments? Are there any tax liens against you? Have you declared bankruptcy in the past 10 years?
In addition to asking questions about your personal credit, a lender may apply a “Fair Isaac” score. This is a mathematical score that weighs several factors, including how long you’ve lived at your current address, your job or profession, and your debt-to-income ratio. This score also considers the amount of credit that’s been extended to you, how much you’ve used, and how long you’ve had these credit lines.
& #149; Credit. Have you consistently paid your bills to your suppliers and other businesses? Are your payments to other financial institutions current?
A potential lender will check your payment history with its credit-reporting agency. These agencies issue reports that contain information about your loans, property tax and child support payments and credit limits, which they receive from the companies that have extended you credit or lent you money.
You can obtain a copy of your credit report any time, and experts recommend that you check your credit report at least annually to confirm that the information it contains is correct. If you have recently been denied credit, you may request a free copy of your credit report. The three major credit reporting agencies are Equifax, Trans Union and Experian (TRW).
& #149; Cash flow. How steady and predictable is your cash flow? Most banks are cash flow lenders. That means they look at the cash flow of your business as the primary repayment source for the money they lend you.
How do you compute cash flow? A company’s cash flow is its net profit, plus its non-cash expenses , depreciation and amortization. One rule of thumb: for every $1 in total loan payments, your business should generate $1.50 in cash flow.
& #149; Capacity. How would you repay your loan if a sudden economic downturn cut into your business revenues? Do you have the capacity to convert other assets to cash?
For example, could you sell or borrow against your real estate holdings, certificates of deposit and stocks? Do you have other savings that you could liquidate quickly to meet your payment obligations?
To check your capacity, lenders are likely to ask you for a personal financial statement as well as your business balance sheet and recent tax returns.
& #149; Collateral. Do you have enough collateral? If you apply for a secured loan, your lender will want you to pledge something that you own, such as CDs or stocks, or business assets like real estate, inventory, equipment, or accounts receivable.
If you apply for an unsecured loan, your lender will not look for collateral. Instead, it will focus on character, credit, cash flow and capacity.
– No Credit History Can Be A Catch-22
What if you have no personal credit history? What if you’ve just started your business or soon plan to do so?
Personal references, business experience, and work history can sometimes substitute. But there are other ways to build your credit standing.
For example, open a checking account, and pay all your bills , rent, electric, phone, medical , consistently and by the due date. These payments will be reflected on your credit record, helping to show prospective lenders that you have the willingness and the discipline to pay your debts , and your future obligations.
Another step you can take is to apply for a loan and ask a relative or friend with good credit to co-sign your application. As a co-signer, your friend “lends” you his or her good credit standing and promises to repay the loan if you don’t.
After you have used the credit account responsibly for one year, apply for credit on your own.
You can also consider applying for a secured business credit card. A credit card is secured when it is backed by money you hold in a collateral account.
After a period of time making on-time payments and keeping a good credit standing, a business owner may qualify to graduation to a partially secured product or to an unsecured business card.
– Building Credit With Secured Card
For small businesses, access to credit is vital. Some financial institutions now offer secured business credit cards. These cards are especially suited for business owners who need to build their business’ credit profile.
Some accounts may allow you to earn interest on the collateral account, which is used to secure the credit card spending limit.
You can use a secured business credit card for all types of business expenses. And this type of credit card can benefit your business in other ways as well.
& #149; By giving you access to additional funding, the credit available on this card may serve as a valuable cash flow tool for your business.
& #149; If you are a business owner that relies on personal credit to help run the business, a secured business credit card will enable you to increase the amount of credit available.
& #149; It helps you build your company’s credit, which enables your business to compete for government contracts.
& #149; Cards can be issued to your employees to make it easier for them to make business purchases and to help your business track their expenses.
& #149; You’ll receive monthly statements and quarterly reports detailing all charges, which will simplify your record keeping.
& #149; You can use it to keep your personal expenses separate from your business expenses.
Banks are in the business of lending money to businesses that need money. If you need business credit , for a specific purpose, for ongoing expenses or for expansion , work with your business banker to find the loan, line of credit or credit card that will help you achieve your goals.
Rozsa is senior vice president and Southern California regional manager of SBA lending for Wells Fargo Bank.