How Credit Agencies Determine a Business's Credit Rating
Not unlike a personal credit rating, a business's credit rating is a review of the company's transaction history. Such a rating is used to measure the level of financial risk of the business to a lender and the probability of the business defaulting on the loan.
The information used to create a rating is gathered from companies with which the business has had financial relationships, such as suppliers or other lenders. Additional data can be included from corporate finance reports, business filings, or lawsuits, as well as liens and judgments filed against the company.
Among the primary determining factors of a business's credit report is how prompt the business is in meeting its payment obligations, such as paying suppliers, repaying loans, and paying monthly leases and bills. Does it pay on time, or is it late with payments? What is the structure of the company's debt? Are loans secured or unsecured? How much debt is the business carrying? Along with the payment history, strong consideration is also given to cash flow, the financial resources of the company, working capital, and net worth.
The fiscal information, however, is not considered in a vacuum. The business profile is also factored in, including the business's size, history, and reputation, along with the background of the principals and company stock, number of employees, and structure of the business. By factoring in the business profile, the rating will also reflect the size and scope of the business.
All these factors are included in a mathematical formula that comes up with a credit rating. The credit rating illustrates whether a business:
- Is responsible in its payment procedures;
- Has the assets to repay debts or provide collateral if necessary;
- Has the character and background to stand behind its business transactions.
A good credit rating provides a company with the ability to obtain the necessary funding for expanding or purchasing new equipment. It can also help in matters of liquidity, ensuring that the business has the necessary cash on hand for day-to-day operations.
In addition, a good credit rating can benefit your business if you're looking to:
- Partner with another company;
- Increase your inventory;
- Hold a special promotional event;
- Increase your line of credit;
- Attract new investors;
- Sell the business.
To enhance your chances of obtaining a higher business credit rating, separate your personal credit from your business credit. This means that you want your business to be structured as a corporation (an LLC is most common for small businesses). Although one of the major credit reporting companies now has a score that reflects the combined business and personal credit lines of an entrepreneur, it's best to separate the two as soon as you can.
You'll also want to make sure your business has all the necessary licenses, and is registered with the major reporting companies such as Experian and D&B. It's important to do most of your business with companies that will report to the major credit reporting agencies. After all, you can have a marvelous track record for paying everyone on time, but if it's not being reported, then it won't factor into your credit rating.
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