Credit Scores And Reports: A Complete Guide For Small Businesses
Did you know that small businesses make up 99.9% of all US businesses and employ more than 60% of the labor force? With such a significant contribution to the economy, it’s no wonder that the creditworthiness of small businesses is of great importance to lenders and other financial institutions.
As a small business owner, your credit score and credit report can significantly impact your ability to secure financing and other forms of credit. But what exactly are credit scores and credit reports, and how do they work for small businesses?
This guide will provide a complete overview of credit scores and credit reports for small businesses, including how they’re calculated, how to access and review them, and how to improve them. Understanding and managing your credit can increase your chances of securing the financing and credit your business needs to thrive.
What Are Credit Scores And Reports?
A credit score represents your business’s creditworthiness. It’s based on the information in a credit report, a detailed record of your business’s credit history.
Credit reports contain detailed information about a business’s credit history, including the following:
- their payment history
- credit utilization
- the types of credit they have used
Credit reports also include personal information, such as:
- an individual’s name
- employment history
Small businesses can also have credit reports, which lenders and other financial institutions use to assess the risk of lending money or extending credit to the business.
How Are Credit Scores Calculated?
Credit scores are calculated using information contained in credit reports, which are maintained by credit reporting agencies (CRAs). The US’s three major credit reporting bureaus are Equifax, Experian, and TransUnion. These CRAs collect information about an individual’s or a business’s credit history from various sources, including banks, credit card companies, and other financial institutions. You can read more about this here.
Several different credit scoring models can be used to calculate a credit score. The most widely used credit scoring model in the United States is the FICO® Score, which the Fair Isaac Corporation developed. The FICO® Score is based on a range of 300 to 850. A higher score indicates a lower risk of default and better credit history.
Five factors are considered when calculating a FICO® Score:
- Payment history: It accounts for 35% of the credit score and includes whether an individual or business has made timely payments on their credit accounts.
- Credit utilization: It accounts for 30% of the credit score and measures how much of an individual’s or business’s available credit is being used. It’s generally recommended to keep credit utilization below 30%.
- Length of credit history: It makes up 15% of the credit score and measures the length of time an individual or business has had credit accounts. A longer credit history can be beneficial for a credit score.
- Credit mix: It’s worth 10% of the credit score and measures the variety of credit accounts an individual or business has, such as credit cards, mortgages, and loans.
- New credit: It makes up 10% of the credit score and measures the number of new credit accounts an individual or business has recently opened. Opening many new accounts simultaneously or consecutively can hurt a credit score.
Remember, credit scores can change over time based on an individual’s or business’s credit history. Regularly review your credit report and take steps to improve your credit score if necessary.
What Factors Influence My Credit Score?
In addition to the factors above, other things can affect your credit score, such as the following:
Filing for bankruptcy can have a significant impact on your credit score. A bankruptcy filing typically stays on your credit report for up to 10 years and can significantly lower your credit score.
The two types of bankruptcy are stated in Chapter 7 and Chapter 13. Chapter 7 bankruptcy, or ‘liquidation’ bankruptcy, is when the assets are sold to pay off as much debt as possible. Meanwhile, Chapter 13 bankruptcy, or ‘reorganization,’ is when the entity develops a plan to pay off its debts over three to five years.
A foreclosure can significantly impact a small business’s credit score. Like an individual’s credit score, a foreclosure can stay on a small business’s credit report for up to seven years and significantly lower its credit score.
When a small business defaults on a commercial property mortgage, the lender may initiate foreclosure by filing a notice of default. The lender may schedule a foreclosure sale if the small business does not bring the loan current within a certain period. The lender will sell the property to the highest bidder at the sale to recover the loan’s outstanding balance.
It’s a legal claim placed on a small business’s property as security for paying a debt. Liens can affect your credit score in several ways.
If a lien is placed on a small business’s property and the business does not pay off the debt that the lien is tied to, the lien may be enforced, and the property may be seized and sold to pay off the debt.
In addition, a lien may appear on a small business’s credit report as a debt owed. A lien on a credit report can lower a small business’s credit score because it shows that the business has outstanding debt secured by a lien on its property.
How Can I Improve My Credit Score?
Improving your credit score as a small business can help secure loans, lines of credit, and other forms of financing, as well as potentially lower the interest rates you pay on those loans. Here are steps to improve your credit score as a small business:
- Pay Your Bills On Time
Late payments can hurt your credit score because they show that you’re not managing your debts responsibly. There are several reasons why you must pay your bills on time as a small business, including the following:
- Avoids late fees
- Maintains a positive credit score
- Maintains good relationships with creditors
- Avoids legal action
To pay your bills on time as a small business, you can:
- Set up automatic payments to ensure you don’t forget to pay a bill.
- Create a billing calendar that lists your bills and due dates. It can help you track when payments are due and ensure you don’t miss any deadlines.
- If you’re having trouble paying a bill on time, contact your creditor to discuss your options. They may be able to work with you to come up with a payment plan or adjust the due date of the payment.
Paying your bills on time and using credit responsibly can improve your credit score and build a strong financial foundation for your small business.
- Keep Balances Low
Using a high percentage of your credit limit can hurt your score, so try to keep balances low. Here are reasons to keep your balances low as a small business:
- Maintains a high credit score
- Saves money on interest
- Improves cash flow
To keep your balances low as a small business, you can:
- Only use your credit for necessary expenses and try to pay off your balances in full each month.
- Keep an eye on your credit utilization below 30% of your credit limit.
- If you have multiple debts, focus on paying off the ones with the highest rates to save money on interest and reduce your overall debt burden.
By keeping your balances low and using credit responsibly, you can improve your credit score and build a strong financial foundation for your small business.
- Diversify Your Credit
Having various credit accounts, such as a mortgage, a car loan, and a credit card can help improve your credit score because lenders want to see that you can manage different types of credit responsibly.
Here’s why you must diversify your credit as a small business:
- Improves your credit score
- Shows financial stability
- Improves your creditworthiness
To diversify your credit as a small business, you can:
- Get a business credit card. A business credit card can be an excellent way to diversify your credit because it’s a type of credit specifically designed for businesses.
- Applying for a business loan can also help diversify your credit because it’s a different type of credit than a credit card.
- Use trade credit. Trade credit is credit that is extended to a business by its suppliers. You can diversify your credit and improve your cash flow by using trade credit.
It’s important to note that having many credit accounts is not necessary to diversify your credit. Instead, focus on having a mix of other credits, such as a credit card and a business loan, to show lenders that you can manage different types of credit responsibly.
- Monitor Your Credit Report
As a small business, monitoring your credit report helps identify errors, protects against identity theft, and monitors your credit score.
To monitor your credit report as a small business, you can:
- Get your credit report copy from any of the major credit bureaus.
- In addition to checking your credit report, you can monitor your credit score to see how your credit changes over time. Several websites and apps offer credit score monitoring services for a fee.
- Dispute errors with the credit bureau that issued the report. The credit bureau will investigate the error and make any necessary corrections.
By monitoring your credit report and taking steps to correct any errors or discrepancies, you can help maintain and improve your credit score as a small business.
- Never Apply For Too Much Credit At Once
Applying for too much credit at once can negatively impact your credit score as a small business because each time you apply for credit, lenders will conduct a credit check, resulting in a ‘hard inquiry’ on your credit report. Hard inquiries can hurt your credit score because they show that you’re seeking a significant amount of credit in a short period.
You must avoid applying for too much credit at once as a small business because of the following reasons:
- Maintain a high credit score
- Avoid unnecessary credit inquiries
- Improve your creditworthiness
To avoid applying for too much credit at once as a small business, you can:
- Before applying for credit, think carefully about how much credit you need and how you will use it. It can help you avoid applying for more credit than you need.
- Before applying for credit, shop for the best terms and rates to avoid applying for credit at multiple lenders and limit the number of hard inquiries on your credit report.
- If you need to borrow money, consider using a credit card instead of applying for a loan. Credit cards often have higher credit limits than loans, which can help you avoid applying for too much credit at once.
By avoiding applying for too much credit at once and using credit responsibly, you can help maintain and improve your credit score as a small business.
- Use Business Credit Cards
Using business credit cards can be a helpful way to improve your credit score as a small business, as long as you use them responsibly. Business credit cards can help you diversify your credit, build a credit history for your business, and demonstrate to lenders that you can manage credit responsibly.
Here are the benefits of using business credit cards for a small business:
- Builds a credit history for your business
- Diversifies your credit
- Manages expenses
To use business credit cards effectively as a small business, you can:
- Get a credit card that offers rewards or other benefits relevant to your business, such as cashback on business-related expenses or discounts on travel.
- Be a responsible credit card user by paying your bills promptly and keeping your balances low.
- Monitor your credit utilization.
Following these steps, you can work to improve your credit score as a small business and increase your chances of getting approved for financing. Be consistent and patient, as it can take time to see improvement in your credit score.
How To Access And Review Credit Scores And Reports
There are several ways to access and review your credit score and credit report. Here are a few options:
- Order a copy of your credit report: Under US federal law, you have one free-of-charge credit report from each of the top major credit reporting giants (Experian, Equifax, and TransUnion) every 12 months. You can request a free copy online at https://www.annualcreditreport.com by phone or mail.
- Check your credit score: Many credit card companies and banks offer free access to your credit score to benefit their customers. You can also check through websites online.
- Purchase a copy of your credit report: If you need to access your credit report more frequently than once every 12 months, you can purchase a copy from a credit reporting agency or a third-party provider. These reports may come with a fee.
Maintaining and improving your credit score is essential to running a successful small business. Your credit score impacts your ability to get loans or credit cards and the terms and rates offered. By understanding your credit score using this guide, you can ensure that you have the financial resources you must grow and succeed.