Why Business Credit Is Important for Small Businesses
As important as business credit is to the life and future of small businesses, a shocking number of small business owners don’t know about this important financial asset and instead turn to personal credit cards when they need to pay for advance purchases. Even before the pandemic, surveys by the National Small Business Association revealed that up to 27 percent of businesses said they were unable to obtain the funding they needed. This means a lack of funding was the primary reason they were unable to grow their business.
To avoid this roadblock to growth and success, to protect personal credit and assets, and to improve a business’s finance capacity, entrepreneurs and owners need to build a business credit profile and know how to use it.
What is business credit?
Business credit, also called commercial credit, is the ability of a business to borrow money from a creditor, like a credit union, for business expenses. It’s an avenue to pay for a variety of expenses, allowing for larger purchases than if a personal credit card or personal loan were used. Business credit also describes when one business issues another credit—a food vendor allowing a restaurant to purchase ingredients ahead of time, for example. This is also called trade credit and can be beneficial for both companies.
Business credit is the largest source of lending in the world; it’s that important.
Why is it important?
There are many reasons why a business might need a large amount of money upfront for a purchase or investment that will help generate income down the road. Business credit allows these kinds of purchases and investments to be made when needed, without having to dip into the cash register.
Business credit also increases the value of a company. Business credit and an accompanying credit score are considered assets when calculating the value of a business. A business credit score is transferable if the business is sold, so a future owner will benefit from the work of the previous owner.
Securing business credit protects the owner’s personal credit and assets. Often, especially early in a business’s life, an owner will use their personal credit cards or a personal loan to pay for business expenses. There are three major drawbacks to this:
- It robs the business of the chance to build a business credit report and increase its value and finance assets.
- It limits the amount of money that can be borrowed because personal loans and credit cards typically have lower borrowing limits than a business loan or line of credit.
- It jeopardizes the owner’s credit report if the business can’t make a payment, and it increases the owner’s debt-to-income ratio if they try to apply for another loan or open another credit card. Mixing personal and business finances is rarely a good idea.
How do you set up a business credit profile?
To create a business credit profile, the owner must first incorporate the business or form an LLC to legally separate themselves from the business. Next, the business will need a federal tax identification number (EIN) from the IRS. This is like a social security number for businesses. The business will also need a phone number and registered address, preferably separate from the owner’s personal phone and address.
With this information, a business checking account can be set up at a local credit union. To open a business checking account and apply for a business credit card, the owner will want to have any financial statements and the business plan on hand.
Finally, the owner will want to open a credit file with the four major business credit bureaus: Dun & Bradstreet, Experian Business, Equifax Business, and Business Credit USA. When another company opens up trade credit with the small business or when a business credit card is opened, it’s important that all of this activity is reported to the credit agencies so the credit profile is expanded to build a history of good credit use and payment. Unlike with personal credit cards and loans, business credit transaction information is sent voluntarily to the bureaus, so it’s important to work with vendors and a creditor who agree to submit your credit payment information.
What is a business credit score?
A business’s credit score falls on a scale of 0 to 100, with 75 and higher considered an excellent rating. The higher the score, the lower the lending risk and therefore the better credit and loan terms from lenders.
Much like a personal credit score, a business credit score is based on credit obligations, repayment history, number of inquiries made on the credit profile, and legal filings—including tax liens, judgements, and bankruptcies—in addition to how long the company has been in operation, business type and size, and repayment performance as compared to similar companies.
Small businesses benefit from starting the conversation early about obtaining business credit and building a favorable credit score. And local credit unions are the perfect partners for small, local businesses taking this step!