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Published By Credit Suite at September 15th, 2020
Effective hiring should be on every business owner’s list.
I once spoke with a small business owner who had recently won a multi-million dollar consulting contract with the U.S. government. This contract required him to seriously ramp up his operation with more employees and the additional infrastructure that he would need to accommodate the increase in headcount. A problem most small business owners would like to face, right?
He had a lot of experience working with government contracts. And he was familiar with the payment cycle for the invoices he regularly sent for payment. He knew he would be paid. But he also knew it would take over 30 days. This made it difficult to float all the ramp-up costs with his cash flow.
This is a common challenge faced by many small businesses that need to ramp up to service a new client or meet the demands of a new contract. Fortunately, this business owner could access borrowed capital to meet this short-term need. Fueling growth is a good use case for borrowed capital. His credit profile allowed him to meet the demands of his new government contract without the insurmountable cash flow burden that would have otherwise been required.
Proactively approaching your credit profile today, to turn it into a tool that you can strategically leverage to foster growth when needed—which often means hiring more employees—should be top of mind for every small business owner.
Building a strong credit profile isn’t rocket science. But it isn’t something that just happens either. What’s more, if you have a less than perfect credit profile, it isn’t going to change overnight. Slow and steady wins this race.
For most small business owners in the United States, your personal credit score will be a part of every business creditworthiness conversation so it’s important to understand what lenders see when they look at your personal score. Fortunately, so far as personal credit is concerned, your score is easy to translate. Here is what it means:
A credit score of 800 or better puts you in pretty elite company. Borrowers in this range are considered consistently responsible when it comes to managing debt. They have a long history of no late payments. Plus they carry low balances on their personal credit cards. They are considered at low risk of default.
This is considered a very good score and tells lenders you are generally financially responsible when it comes to money and managing your personal credit. Although you may have an occasional late payment, most of the time you make timely payments on your personal loans, credit cards, utility payments, and mortgage. It also indicates that the balances you carry on your personal credit cards are generally low (below 30% of available credit).
If your score falls in the upper part of this range, you are a little better than the average U.S. consumer whose FICO score is around 704. Although this borrower shouldn’t have too much trouble obtaining financing, there will be some options unavailable to them. Although they are unlikely to be offered the same low rates and favorable terms of those with Very Good or Excellent credit.
Borrowers in this range may have a few dings on their credit history, but no serious delinquencies. It’s still possible to get financing. But it will not be at very competitive rates. There will be limited options.
This score represents what could be multiple defaults on different loans from different lenders. It could also represent a bankruptcy, which will remain on your credit report for 10 years. Borrowers with scores this low will have very limited business loan options. They should expect to pay some of the highest rates on business financing if approved. Borrowers with a score in this range should focus on repairing and rebuilding their score.
Although there is a difference between Poor Credit and No Credit, the results are similar. When building a personal credit history, don’t be afraid to start small. Make sure you pay your utility bills and meet your other personal financial obligations in a timely manner.
Now that you know what your personal credit score means, you need to know how it’s calculated so you can take the right steps to build or improve your score.
Most of the personal credit reporting bureaus base their credit scores on the FICO score. Although if you check your score with different reporting agencies there might be some slight differences, the basis for those scores is all the same. Here is the formula:
In other words, the single most important thing you can do is to make each and every periodic payment in a timely fashion. Most creditors understand the difficulties people are facing right now. But that doesn’t mean you’ll get a pass. It’s important to stay current. Do not let a debt obligation go 60-, 90-, or 120-days past due.
In other words, the ratio of debt you use compared to the amount of credit you have. The credit bureaus don’t like to see maxed out credit accounts. A good rule of thumb is to keep that ratio below 30% (lower is even better). But anything over 50% is a big red flag that will keep your personal credit score in the basement.
Lenders are trying to make decisions about what you will do in the future based on what you’ve done in the past. So a longer track record is better than a shorter track record. You’ll probably get some allowance for the first half of 2020. But if you have chronic credit problems dating from before the crisis, you need to get to work on making improvements to your credit habits.
For example, credit bureaus look at mortgages, auto loans, credit cards and other revolving debt through a different lens. Creditors want to see a mix of credit. So if the only credit account you have is your mortgage, a little diversification will help your credit score.
While it’s true that new inquiries can impact your score, the amount of impact is relatively small. That is particularly true if you are consistently current with your payments and aren’t maxing out the limit on your credit cards every month.
Before we talk about how to improve your credit to maximize your ability to access borrowed capital to hire new employees or otherwise ramp up for a new contract, we need to address business credit. What makes it different from personal credit and some of the synergies created by a strong personal credit score and a robust business credit history.
Like the credit bureaus that report on your personal credit history, there are business credit bureaus that report on your business credit history. They consider how you pay your suppliers, your landlord, your utilities, your business credit cards, and how you may payments on any other business loan or business debt you might have.
With the exception of the FICO SBSS credit score, which is a composite of your personal and business credit used by the SBA to evaluate a loan application, you should consider your business credit as typically a collection of scores, rather than one universal score like your personal score. Every business credit bureau creates this profile differently. So no two business credit reports will look exactly the same. Regardless of how long you’ve been in business, you have a business credit profile that includes detailed information about your business and your business credit history.
Although your personal score is considered private, your business profile is public to anyone who wants to see it. The basis of your business profile is whether or not the majority of your credit interactions are positive or negative. The goal here is to meet all your business obligations as agreed upon.
Additionally, your credit history is a measurement against other businesses in your industry. And this includes if they are considered more or less risky from a credit perspective. Your history is also compared to other businesses in your region, of your size, and annual revenues. This is to make a recommendation to creditors on your business’s potential creditworthiness.
Irrespective of personal or business credit, the single most important thing you can do to build a positive profile is to make your periodic payments in a timely manner. If you want to build your credit into a strategic tool you can use to fuel growth, here are 4 things you should start doing today:
There is a lot of negative credit activity going on right now. Plus, it’s easy to confuse businesses with similar names or addresses. So it’s more important than ever to make sure the things reported about your business are accurate and reflect your credit practices. If you find an error, all the major business credit bureaus have mechanisms to correct the mistakes you can verify.
This can be hard for young businesses that don’t have a lot of business credit yet. But using your personal credit for business credit purposes not only doesn’t help your business profile, it could actually hurt your personal credit score. Since 30% of your personal score comes from how much credit you use compared to how much you have, the higher balances often associated with business expenses can negatively impact your ratios. If you want to keep your personal score as strong as possible, while building your business profile, avoid the temptation to use your personal credit to pay for a business expense.
This is one of the most underrated ways to build a strong business profile. Most vendors are willing to offer payment terms to their good customers. Although it’s not a business loan, if they report your good credit behavior to the appropriate credit bureaus, this valuable credit will help you build a strong business credit history. This will enable you to borrow when you really need to.
Businesses large and small leverage borrowed capital to fuel growth and fund other business initiatives like effective hiring of new employees. The biggest thing you can do to build a strong profile is to use the credit you need and make sure you make every periodic payment. Lenders look at your history because they want some assurance that you will make timely payments to them. It helps if they can see you’ve done so in the past.
Effective hiring of new employees often includes expense beyond the addition of another paycheck. For some companies it might be a new computer and workstation. For others it could be something else. Most of these upfront expenses are relatively short term. So many small business owners opt to finance them with either a business credit card or even a small business loan depending on the cost. The business owner I described at the beginning of this article opted for a small business loan.
He had worked to build his credit profile so he could use business financing as a strategic tool when he needed it. So he could borrow the money he needed to ramp up employees and infrastructure to service the new contract. And he could repay the loan once he started to get regular payments from his government contract.
As a small business owner accessing borrowed capital has always required a good personal and business credit history. But especially now, many lenders are tightening their qualification requirements tighter than ever. So it will be important to make sure your profile shows you in the best light possible. Of course, it’s no guarantee you’ll get the financing you want. But it will give your business more options to choose from—as well as put your application on the top of the pile.