Managing Credit in the Current Economic Climate January 2009
Introduction The economic crisis and tight credit markets necessitate careful management of small business finances and credit history. Obtaining credit is challenging right now, even for entrepreneurs with strong finances and a track record of paying bills on time. Some entrepreneurs who are unable to obtain loans or trade credit are resorting to using credit cards, personal savings, home equity loans or early withdrawals from retirement funds. You can benefit from a keen awareness of your credit profile, and this white paper provides tips to improve your credit rating. The paper also includes debt management advice and a step-bystep worksheet to assist you in determining your fiscal fitness. A glossary demystifies key credit and business terms. Use this tool to help improve your odds of obtaining the financing you need to survive this downturn and flourish when the economy rebounds. 1 P age
Building Your Business Credit Assess Your Finances A good starting point for obtaining credit is to determine the strength or weakness of your financial position. The biggest mistake that small businesses make is failing to track revenues and expenses rigorously, according to Gene Fairbrother, Lead Business Consultant at the National Association for the Self-Employed (NASE). This lack of financial oversight results in a murky grasp on whether a business is operating at a profit or loss. Most businesses don t know where they are today, Fairbrother said. It s beyond them to even guess where they will be in six months. If you think you might need a business loan in three to six months, Fairbrother recommended doing whatever you can now to make your business as profitable as possible so it will be attractive to a prospective lender. Also ensure that you have a solid reason for the loan, such as buying equipment or inventory to expand your business or covering a temporary cash crunch. Prospective lenders will be less interested in loaning you money to meet your payroll or dig yourself out of a severe financial crisis since these are not necessarily business-building activities. To assess your odds of obtaining credit, put yourself in the shoes of a risk-averse lender. Many financial institutions use these 5 Cs to determine whether a business is creditworthy: Capacity: Do you have sufficient cash to service the loan as well as potential future loans? Character: What is your credit history? Are you trustworthy? Collateral: What non-cash business assets can you use to secure a loan? Capital: What is your business s net worth? What is your personal net worth? Conditions: What is the loan s intended purpose? Should any outside factors be considered, such as the current economic situation? Make Information Accessible The profitability of your business is one input in an assessment of your credit strength. Lenders and potential vendors may also review the following sources of information about your company to gain a full picture of your creditworthiness: Credit activity reports from other businesses, utility companies and the like. Credit activity reports and deposit data from financial institutions. Commercial scores that reflect a business s likelihood of making payments on time. Examples include Dun & Bradstreet s PAYDEX score, which reflects a business s payment habits, and Fair Isaac s Small Business Scoring Service (SBSS) SM. You play an important role in making it easy for lenders to use all available information to determine the value of your business. Strive to keep your personal and business assets separate, thereby helping to reduce the impact that business problems might have on your personal credit. 2 P age
This important step will also enable you to establish your company s credit history. To do this, set up business checking and savings accounts, loans and credit lines, and credit or charge cards, and use them exclusively for your business. Very small companies, sole proprietorships and new businesses may have difficulty separating their business and personal assets. These companies typically have very limited business credit information, and, therefore, lenders often rely on what is called a blended score, which is a combination of the personal credit scores of the principal(s) and available business credit data. The business is one aspect of the owner s history, but a lender is also going to look at the owner s personal history. There s no separation between the two at the early stages, Fairbrother explained. If the individual s history is bad, they won t ignore it. 3 P age
Reviewing Your Credit Report A business credit report offers a snapshot of a company s credit history. By reviewing your own report, you can see how attractive you appear to suppliers and lenders. Similarly, you can look at reports on potential vendors and suppliers to determine if you want to do business with them. Key areas to consider in your review include: Company data: A credit report will include a company s name, address and telephone number, as well as other information such as business type, number of employees, years in business, sales figures and key officers. Make sure this accurately reflects your business and report any discrepancies. Credit risk rating: Most credit reports include a rating system to help companies determine your potential risk of making late or delinquent payments. Factors include past payment performance and legal filings. Because of the current economic situation, a high risk rating will be taken very seriously. Payment history: Companies review this section to see how well you pay your bills. If they notice several months of late payments, they may be less inclined to do business with you. Conversely, if you were behind and show a trend of timely payments, it may indicate that you have fixed whatever problems you had. Collections: If your report shows a history of letting bills lapse or having accounts sent to collection, you will seriously jeopardize any chances of getting a loan or signing up a new supplier. If you have an explanation for a late payment, such as a dispute over delivery of merchandise, save all documents so you can explain your situation. Legal issues: Your credit report includes whether you have filed for bankruptcy or have any outstanding lawsuits, liens or court judgments. Again, be prepared to explain what happened. Depending on the circumstances, a pending lawsuit or legal action might not mean anything, but bankruptcies and liens are another story. UCC filings: Your Uniform Commercial Code (UCC) filings describe your liens and leases. If this section shows that you have several assets that have been pledged as collateral on existing loans or a large number of credit relationships with other businesses, lenders and suppliers may decide that you are too risky to assume more debt. 4 P age
Improving Your Credit Rating Your business s credit rating can affect access to deals, partnerships and credit. It also influences the cost of these relationships by shaping the payment terms that vendors grant or interest rates that lenders charge for business loans. Use the following tips to improve your rating: Make timely payments: Pay bills by their due dates or earlier. This shows creditors and suppliers that you are a responsible financial manager. Check your credit report regularly: Review your credit report on a regular basis at least once a year. Make sure all information is current, and be sure your report is complete. For instance, if you have an established credit relationship that isn t included, ask that creditor to notify the leading credit bureaus. Correct errors: If your report contains mistakes, such as closed accounts that are listed as active, contact the information providers to discuss how to correct them. Submit corrections in writing along with copies of all documentation that backs your claim. Keep the originals for your files. If a creditor made a mistake, contact them and request that the error be removed from your record. Get a D-U-N-S Number : Dun & Bradstreet s D-U-N-S Number is a nine-digit number that provides unique identifiers of single business entities, while linking corporate family structures. D&B links the D-U-N-S Numbers of parents, subsidiaries, headquarters and branches on more than 70 million corporate family members. Used by the world s most influential standardssetting organizations, it is recognized, recommended and/or required by more than 50 global, industry and trade associations, including the United Nations, the U.S. Federal Government, the Australian Government and the European Commission. The D&B D-U-N-S Number has become the standard for keeping track of the world s businesses. 5 P age
Understanding Business vs. Personal Credit Reports A business credit rating is determined by credit and business information providers. Besides Dun & Bradstreet (http://www.dnb.com), other major business information providers include Acxiom (http://www.acxiom.com), Equifax (http://www.equifax.com) and Experian (http://www.experian.com). These providers compile information and then assign a commercial or business credit score. This score is meant to help suppliers and lenders determine your likelihood to pay for goods and services, or repay a loan. In order to ensure that your business credit rating is where it should be you need to fully grasp how a business credit rating differs from a personal credit rating. There are three major differences: Multiple accounts: Having several active business checking accounts all in good standing can raise your credit score. This is different from personal credit, where multiple bank accounts may lower your rating. It demonstrates that your business is savvy about managing its finances. Self-reported data: Some of the information in your business profile may be self-reported. You can do this by establishing a profile with the leading credit and business information providers. Supplier assistance: Business creditors don t have to report payments to the information providers, so you may need to ask them to report your payment performance. The information providers strive to make their data as accurate as possible. That s our job. We want to be sure that we represent your business with the most complete and timely information to the many financial institutions, vendors and suppliers that rely on D&B s information to make decisions regarding your business, said Donna Vieira, Leader of the Small Business Credit Products Group at Dun & Bradstreet. 6 P age
Glossary of Key Credit and Business Terms Deft management of your credit report requires an understanding of credit report terms as well as important financial vocabulary. Review the following list to best prepare yourself. Balance Sheet: A summary of a business s financial condition including assets, liabilities and net worth at a specific point in time. Capital Expenditures: Money used for the acquisition of a long-term asset. Collateral: Assets pledged to secure a loan. Commercial Credit Score : This score from Dun & Bradstreet is designed to predict the likelihood that a business will pay its bills in a severely delinquent manner (90 days or more past term), obtain legal relief from creditors or cease operations without paying all creditors in full over the next 12 months, based on the information in D&B s files. A severely delinquent firm is defined as a business with at least 25% of its payments slow and at least 10% of its payments 90 days or more past due. Company Profile: Details about a business, including its name, address, age, business structure, officers and industry. Credit Information Provider: A third party that collects information about the credit transactions of businesses or consumers and supplies the data to lenders and businesses. Credit Rating: A ranking of a business that evaluates the risk of late payment. The rating is based on a number of factors, including a review of a business s transaction history and past payment performance and legal filings. Credit Report: Information detailing a company s payment history, existing credit obligations, legal filings and background. D-U-N-S Number : A number used to uniquely identify a business in Dun & Bradstreet s database. D-U-N-S, which stands for Data Universal Numbering System, has become the standard for keeping track of the businesses around the world. Financial Statement: A written report that describes the financial status of an individual or business. Fixed Asset: A long-term asset, such as real estate, equipment or furniture, that isn t expected to be converted into cash in the current or upcoming fiscal year. Leverage: The degree to which a business is using borrowed money. Highly leveraged businesses may be at risk of going bankrupt. 7 P age
Line of Credit: A promise from a bank or vendor to extend a specific amount of unsecured credit to a borrower for a period of time. A line of credit is usually used for short-term loans. PAYDEX : A score between 0 and 100 generated by Dun & Bradstreet that reflects a business s likelihood of making payments on time. Principal: The outstanding balance of a loan, not including interest owed. Revenue: The total amount of money a business receives for goods sold or services provided during a specified amount of time. Secured Credit: A line of credit backed with collateral, such as cash reserves, inventory or other assets. Sole Proprietorship: A business structure in which the owner has full control and unlimited liability. Unsecured Credit: A line of credit not backed by specific collateral. Trademarks, registered trademarks and service marks are the property of their respective owners. 8 P age
Worksheet: Give Your Business a Credit Check up The economic crisis and tightening of the credit market have made it imperative for small businesses and entrepreneurs to maintain high credit scores personally and for their businesses. The key component of sound credit includes a clean credit report. Use this worksheet to move through the steps required to help you assess your credit. 1. Build a Solid Framework It falls upon you to review your business credit profile annually and address any issues. The first step to take is to obtain copies of your credit report from the major business information providers and review them, making any necessary corrections or clarifying any discrepancies. Major business information providers include Acxiom (http://www.acxiom.com), Dun & Bradstreet (http://www.dnb.com), Equifax (http://www.equifax.com) and Experian (http://www.experian.com). Have you checked your business s credit report in the past year? Yes No Not sure If you answered Yes, determine when you last checked it. If information needed to be corrected or updated, it s a good idea to check the report again and move onto question 2. If you answered No, immediately order a copy of your report and move onto question 2. If you answered Not sure, it s wise to order a copy just so you don t close any avenues you may need to take. 2. Resolve Errors or Discrepancies List any items in your report that need to be resolved, including the action item required (e.g., submit corrections yourself or follow up with vendors or the business information providers to ensure that changes are made). Action Item You Vendor Information Provider 9 P age
3. Rebuild Relationships If your profile contains delinquent information, list the action items you will take to improve your credit (e.g., contact vendor about payment, pay bill on time or early). Action Item Completed Still Must Do 4. Reduce Expenses If you think you might need a business loan in the near future, you need to make your business as profitable as possible. List any expenses that you may be able to lower (e.g., office supplies, phone bills, advertising, staffing). Business Expense Potential Savings 10 P age