The first golden rule to establishing business credit lines is to ask for them. If you don’t ask, no one is going to come over and say “hey, here have some credit”.
There are two main sources of business credit. That granted by a bank or other financial institution, or credit terms given by suppliers. Upon requesting a supplier line of credit – or trade terms, don’t be surprised if they perform some business credit checks. After all, you would, wouldn’t you?
Using a planned approach is essential if you are to successfully build business credit. It is important to have an idea of what you need to prove about your business, if you ever want to consider a business loan, or negotiate credit terms, or extend existing credit terms with suppliers.
It is quite common when you start a business to have to pay for things before you collect monies in. This delay requires funding from somewhere, and normally, either a bank facility or some form of supplier credit will be needed to ease the strain on the owners own capital investment.
Lets look at how credit worthiness is determined. All lenders are concerned with the granting of and repayment of small business loans in accordance with their terms and conditions.
They use what is commonly called the five “C’s” of credit. Cash flow, Capital, Collateral, Conditions, and Character.
The 5 Cs of Credit
Business Cash Flow, or Capacity to repay is always the primary factor. The lender needs to know how your business will generate the repayment.
Establishing business credit needs proof of affordability, and you will often be required to provide detailed cash flow figures from the business.
Your cash flow ultimately determines the timing and the probability of successful repayment of any loan or small business line of credit. A review of your past credit payment history both personal and commercial, will also be undertaken.
Consider using business secured credit cards as an interim measure, whilst you build your proof of ability to repay.
Capital is the money you have personally invested in your business and is an indication of how much you have at risk should the business fail.
Lenders will expect you to have contributed from your own assets and to have undertaken personal financial risk to establish the business, before they will commit to providing a loan or any other kind of business funding.
In the eyes of the lender, if you have a significant personal investment in the business you are more likely to do everything in your power to make the business successful.
Collateral is an additional form of security or guarantee that you will be asked to provide the lender.
For a start up business, the lender may require that you pledge some of your personal assets whose titles would be handed over to the lender if you failed to repay the small business loan.
As an existing small business owner you may be asked to pledge business assets such as equipment, buildings, inventory, or accounts receivable.
A personal guarantee could take the place of secured business assets or could even be required in addition to them before establishing business credit. A family member or friend may need to sign a guarantee document promising to repay the loan if you can’t.
Conditions focus on the intended purpose of the loan and how that relates to the general business climate. Will the money be used for working capital, additional equipment, or inventory?
The lender uses its’ network of information sources to determine the relative stability of the environment in which your business will operate. It often has greater insight into local and regional issues that could affect your industry. To be successful in establishing business credit you’ll need to persuade a lender of the merits of a small business loan.
Character is also a critical factor in establishing business credit. Character is how you present yourself to the lender along with your credentials, your educational background and experience in your industry.
The lender will form a subjective opinion as to whether or not you are not only sufficiently trustworthy, but professionally competent enough to repay the small business loan and generate a return on funds invested in your company.
Character plays a large role in negotiating credit terms with suppliers. Before granting you terms, you will have to fill out a business credit application, and give trade references from suppliers who will vouch for your repayment record.
At first you will be granted maybe only a small limit (low risk to the supplier) on short payment terms. Pay this on time, every time and after a number of months you’ll be in a position to negotiate a larger limit or longer terms.
As a small business owner be conscious of the fact that establishing business credit is not something that needs to be done once, but it is a part of an ongoing process, which will contribute significantly towards any business success.
A history of steadily improving business cash flow as a result of effective business cash controls, retained capital in the balance sheet from making profits, and a clean payment history to your trade suppliers will rapidly build your creditworthiness.