Do you know how to avoid high risk NAICS codes? And build your Fundability™? And what does any of that have to do with how financial institutions view a business? But before we go any further, just what is a NAICS number, anyway?
So the North American Industry Classification System, or NAICS, has its own six digit coding system. This code classifies business establishments for the purpose of collecting, analyzing, and publishing statistical data related to the U.S. business economy. NAICS industry codes define establishments based on the activities in which they are primarily engaged.
For example, if your company makes tires and inner tubes, the NAICS code might be 441320, which is for tire dealers.
But that’s not quite right, now, is it? You’re a manufacturer and not necessarily a dealer. So the NAICS code would start with a string of numerals more like 4420, which is rubber tire manufacturing.
How the NAICS Works
The NAICS sorts businesses for the purpose of gathering, analyzing, and then publishing statistical data related to the United States business economy. The NAICS industry codes thereby define establishments as based on the activities in which they are mainly engaged.
In our tires example, the NAICS has several codes. They correspond to all sorts of stops that tires make along the way from manufacturing to end user. This includes different types of wholesalers and retailers and the like.
Low Risk NAICS Codes vs. High Risk NAICS Codes
The NAICS puts out its own list of high-risk and high-cash industries. Higher risk industries on the high risk business list include casinos, pawn shops, and liquor stores, but also automotive dealers and restaurants. Do you have a high risk business? Then the industry codes NAICS will reflect that on your business credit report.
OSHA requires injury and illness reports from certain high-risk industries.
Keep in mind, that list of high-risk and high-cash industries is a few years old and potentially incomplete, and there are no plans to update it.
However, the NAICS coding system is not the only coding system out there affecting business credit files. Here’s another which is often used. It’s something to pay attention to, for business credit building purposes.
Business SIC Codes
What is a SIC number? The SIC Code (Standard Industrial Classification) is a part of another business classification system.
A Standard Industry Classification code, or SIC is a four digit numerical code which is assigned by the federal government to businesses, to make it easier to identify the primary activity of the business.
This is an indicator of the kind of business a company is in. The Securities and Exchange Commission developed this system. For example, in our tires case, then your SIC code would be 3011. The numbers are somewhat intelligent in that there are ranges of industry groups which correspond to the first of the four digits, such as manufacturing corresponds to four digit SIC codes that start with either a 2 or a 3.
The combination of the first and second digits then defines the major industry group in small business SIC codes. In our example, 30 designates ‘Rubber and Miscellaneous Plastic Products’.
The SIC code’s digits are grouped to identify the industry and its group. The first two digits in the SIC code identify the major group, the third digit identifies the industry group and the fourth digit identifies the industry.
In fact, the Internal Revenue Service will use the SIC code that you select. This is in order to determine if your business tax returns are comparable to the other businesses in your industry. Therefore, if your tax deductions do not reasonably resemble the other businesses in your industry, your business could be audited.
This means the IRS is looking where to find NAICS code on tax return – your tax return.
Low Risk SIC Codes for Businesses vs. High Risk SIC Codes
Furthermore, some companies may be labeled high-risk when they do not select the right SIC codes to classify their company. However, if you understand how the business classification system works, then you can choose the correct code on your first try.
Which Coding System do the Banks and the Business Credit Reporting Agencies Use?
Business credit bureaus and small business lending institutions use both. However, the SIC code system is phasing out and NAICS codes will replace it. But for the moment, assume they are both in play, as the transition has not yet finished. These coding systems are similar but not identical.
Lenders, banks, insurance companies and business credit reporting agencies use the two business classification systems to see if your business is a high-risk industry classification.
This means that you could get a denial for a loan or a business credit card based on your business classification. Some SIC codes can trigger automatic turn-downs, higher premiums, and reducing credit limits for your business.
You must be careful when you choose NAICS codes for your company. The Internal Revenue Service will use the NAICS code that you select. This is to determine if your business tax returns are comparable to the other businesses in your industry.
Therefore, if your tax deductions do not reasonably resemble the other businesses in your industry, your business could be subject to an audit.
Furthermore, some companies are labeled high-risk when they do not select the right NAICS codes to classify their company. But if you understand how the business classification system works, then you can choose the right code on your first try.
True Injury Risks According to the CDC
In 1999, the Centers for Disease Control published an article on risks in small businesses. This article contains information on SIC codes and gives information on injuries associated with the codes.
While this is not the true means by which lending institutions decide on risk, it is still of interest. And it can show what may be behind some of the reasoning. This could be the answer to what is NAICS code used for.
Part of the calculus of risk comes from occupational injuries such as those noted in the CDC report. But the other side of the risk coin is occupations which are cash intensive businesses.
After all, a pawn shop might not have much of a specific risk of injury at all. But the large amounts of cash normally associated with one mean that it’s a tempting target for thieves.
Avoid High Risk NAICS Codes and Choosing Better NAICS Codes
Let’s go back to our tire example for how to choose the proper NAICS code for your business. The first two digits of the SIC code will identify the major industry group. Then for the business activity code NAICS, the third digit will identify the industry group. And then the fourth digit will identify the industry. This is how these agencies classify businesses.
Now you should learn how to get a NAICS code.
Here’s how to get NAICS code for your company:
- Go to naics.com
- Use their search function and their business activity code lookup
- Select the closest fit – if there is no good fit, search again for other NAICS business codes
You Can Avoid High Risk NAICS Codes
There are certain high risk NAICS codes which will get you a loan denial if you choose them for your business classification. So before you choose your SIC code and NAICS codes, look over the high risk industries list of cash intensive businesses and more. Do so before you begin to build your NAICS codes.
Here are some high-risk industries codes you should be aware of:
- Automotive sales
- Money lending and collecting
- The travel industry
- Real estate investing (this is potentially where the NAICS code for real estate would be – the NAICS code for real estate is 531390 for Other Activities Related to Real Estate)
- Anything else with reference to investing of any type
- Adult entertainment
- Dry Cleaning establishment
Avoid High Risk NAICS Codes: Back to Our Example for a Moment
But what is the NAICS code? For automotive sales, for example, you would normally select 441110, ‘Automobile dealers, new only or new and used’.
However, most lenders will automatically turn your business down because of the high-risk factor within the business classification name. Of course you want to be honest with your NAICS coding classification.
However, if more than one NAICS code could apply, don’t worry. Because there is nothing wrong with choosing company NAICS codes which will not get you denied by lenders.
Therefore, if you want to have your automobile sales company, you need a business code which has something like automotive parts written in the actual business code. That way, you can still operate your real business of “automotive sales” without being considered risky.
You’ll be fine, even as lenders search companies by NAICS code, using an NAICS lookup by company name. A better NAICS code can be the difference between business funding – and no funding.
Avoid High Risk NAICS Codes: Takeaways
Choosing the incorrect NAICS code could end up costing your business and get you labeled as high-risk. So this could directly impact your insurance premiums, your financing ability, even your credit limit recommendations.
This small error of selecting the incorrect NAICS code could cost your business in the future.
Therefore, be sure to do your research before you select an NAICS code for your business.
Restricted industries (automatic decline) include:
- Ammunition or Weapons Manufacturing; wholesale and retail.
- Bail Bonds
- Check Cashing Agencies
- Energy, oil trading, or petroleum extraction or production
- Finance: Federal Reserve Banks, foreign banks, banks, bank holding companies (This is likely where you would find the NAICS code for a holding company.), loan brokers, commodity brokers, security brokers, mortgage brokers, mortgage bankers, mortgage companies, bail bond companies, or mutual fund managers).
- Gaming or Gambling Activities
- Loans for the speculative purchases of securities or goods.
- Pawn shops
- Political campaigns, candidates, or committees
- Public administration (e.g., these are city, county, state, and federal governmental agencies).
- X-rated products or entertainment
High Risk Industries (subject to stricter underwriting guidelines):
- Agriculture or forest products
- Auto, recreational vehicle or boat sales.
- Courier services
- Computer and software related services.
- Dry cleaners
- Entertainment (adult entertainment is to be considered restricted).
- General contractors (here is where you would likely find the general contractor NAICS code)
- Gasoline stations or convenience stores (also known as c-stores)
- Healthcare; specifically nursing homes, assisted living facilities, and continuing care retirement centers.
- Special trade contractors
- Hotels or motels
More High-Risk Industries
- Jewelry, precious stones and metals; wholesale and retail (this could be where to find the NAICS code for retail sales).
- Limousine services
- Long distance or “over-the-road” trucking.
- Mobile or manufactured home sales.
- Phone sales and direct selling establishments
- Real estate agents/brokers (this is potentially where the NAICS code for real estate holding company would be)
- Real estate developers or land sub-dividers
- Restaurants or drinking establishments.
- Software or programming companies
- Taxi cabs (including the purchase of cab medallions) .
- Travel agencies