Whether seeking financing, a loan, or a line of credit from a new supplier, your credit score can greatly influence your chances of obtaining said credit. A good credit score symbolises strong financial health and can positively impact your reputation with suppliers, partners, and customers. A low score can stifle expansion ambitions, while a high score can fuel growth. Given its importance in this regard, companies should ensure they maintain a good rating.
Understanding how a credit rating works (and the wider ramifications for your business) is crucial if you want to take steps to improve it. In this blog, we’ll help you to do just that, exploring answers to:
- What is a business credit score?
- The importance of business credit scores
- How does a business credit score work?
- How is business credit score calculated?
- Factors affecting the credit score of a business
- What is a good and bad credit score
- How to improve business credit score?
- The role of financial management software in improving credit score
What is a business credit score?
A business credit score is essentially a numerical rating assigned to businesses, assessing their creditworthiness. This score reflects their capacity to repay debts and fulfil financial obligations. It is based on several factors, including the company's financial wellbeing, credit track record, historical payment behaviours, business profile, and publicly accessible information (like governmental submissions and legal records).
The importance of business credit scores
A company's credit score holds immense importance as it's often the first metric evaluated by investors and creditors, directly influencing access to financing or credit. Banks also take it into consideration when assessing loan approvals, with those below the minimum threshold often being denied or offered loans with higher interest rates.
In B2B trade, this rating dictates a business's ability to acquire goods or services on credit and the associated terms and conditions. Companies with good or high scores are recognised for their track record of timely payments, earning them a reputation as trustworthy partners in business. Consequently, they hold a competitive edge to secure good deals. This advantage has a direct impact on the business's cash flow, as it enables securing necessary supplies on credit with favourable terms, giving them the flexibility to defer payments for materials until after completing their sales cycle (rather than paying upfront).
Additionally, a solid credit score is essential for excelling in the company credit checks conducted during tendering processes or potential business partnerships. These checks evaluate financial stability and reliability, determining eligibility for partnerships or ventures.
The credit ranking helps businesses to assess their financial health and proactively manage risks so that they can avoid future financial challenges. A declining score serves as a warning sign to review finances and implement necessary measures for stability.
How does a business credit score work?
Unlike personal credit scores, business credit ratings are not private. Authorised parties, such as lenders and partners, can access it.
Entities authorised to compute and allocate credit scores to businesses are termed Credit Reference Agencies (CRAs). Notable CRAs operating in the UK are Experian, Equifax, CreditSafe, and Dun & Bradstreet. Governed by the Financial Conduct Authority (FCA), these agencies are obligated to adhere to pertinent legislation and data protection regulations.
These CRAs collect information about the company being assessed from various sources, including their suppliers and lenders, credit card companies, public records from state filing offices, court filings, and collection agencies.
How is business credit score calculated?
Each CRA has its own rating system, criteria, and own proprietary model for calculating the credit score. Hence the score for the same company can vary, however, all are based on some common factors. These include:
- The company’s payment history: It is evaluated considering timelines and whether payments (including utility bills) were made on time.
- Outstanding debt: The total debt amount currently owed by the business.
- Financial health: This might include looking at data related to annual reports, balance sheets, income and cash flow statements, profitability, debt-to-capital ratio, and liquidity.
- Legal records: Public records are reviewed to identify any history of bankruptcies, defaults, liens, and other legal involvements.
- General business information: This includes details such as the size of the company, employee numbers, years in operation, as well as the experience and qualifications of the company's management team.
- Industry risks and benchmarks: These are considered, comparing the level of risk associated with the industry in which the business operates and the average performance metrics in the sector to the subject company.
- Credit utilisation: It gives the ratio of available credit to the amount of credit being used.
- The number of recent credit inquiries or applications: Too many inquiries can be a sign of financial mismanagement and troubles.
- Supplier and vendor relationships: These are assessed as the health of the relations can indicate the business’s reliability.
The weigh assigned to each factor in the calculation varies and is reflective of its relative importance to the company's creditworthiness.
Factors affecting the credit score of a business
Delays and inconsistency in paying bills can significantly lower the credit score. Similarly, public records such as County Court Judgments (CCJs) and insolvency proceedings against the business indicate financial troubles and a higher risk, thus impacting creditworthiness.
The length of the credit history also has an influence, with longer credit histories seen as better, as they provide a detailed track record of the company's financial behaviour, aiding in a more accurate assessment of creditworthiness. Similarly, the amount of available information influences the output.
The industry in which the company operates, along with trends and patterns specific to that sector can impact the rating. Credit bureaus use payment behaviour and likelihood of failure within the industry to provide context and make estimates.
Financial statements are critical information for CRAs and hold significant importance, offering insights into the business. Any improvement over time or positive cash flow can boost the score.
Filing accounts late, exceeding overdraft limits, frequent financing applications, and a high credit utilisation ratio are other factors that can have a negative impact.
What is a good and bad credit score?
CRAs have varied rating systems and criteria, so there is no single universal good or bad credit score. However, there are common credit score ranges that determine the risk level.
One prevalent method for credit assessment is the 0-100 rating system, utilised by Experian, CreditSafe, and Dun & Bradstreet. In this system, a score of 0 signals the highest risk level, whereas scores of 80 and above indicate a lower risk profile. A perfect score of 100 signifies optimal credit standing, with close proximity to this reflecting a stronger credit position.
Unlike others, Equifax rates companies on a scale of 0-1000, where 0-438 is considered poor, and anything above 811 is regarded as excellent.
Regardless of the rating system, a lower score corresponds with a higher risk of insolvency or financial difficulty, leading to challenges in securing loans on good terms. Conversely, higher scores indicate strong financial health and debt management capability, resulting in better financing options with favourable terms.
How to improve business credit score?
Building a good credit score takes time and consistent effort. By adopting some best practices, you can support your efforts and consistently elevate your creditworthiness over time:
- Ensure a healthy cash flow by employing efficient management techniques like cash flow forecasting and expense management. This practice is crucial to ensure funds are available for prompt payments, thereby upholding a good payment track record and mitigating the risk of defaults and related legal actions.
- Request your business partners and vendors to report your payment history and relevant trade information to CRAs, as not all of them do. Some CRAs might have specific criteria for including this data, hence aim to work with creditors or vendors that have a history of reporting trade information or payments to CRAs.
- Maintain a healthy credit utilisation ratio, typically considered to be below 30%. A lower ratio signifies good financial health and effective credit management, positively impacting your credit score.
- For early start-ups and microbusinesses, it is best to keep business and personal finances separate. Opt for business finance instead of personal credit or guarantees. This will help build your company credit score and accurately reflect the financial health of the business.
- File full accounts with HMRC and Companies House instead of abridged or filleted accounts. This will provide a more comprehensive picture of your company's financial health
- Consistently review your company’s credit report, verifying its accuracy and timeliness. This proactive approach not only helps identify potential shortcomings but also empowers you to implement corrective actions.
- Monitor the creditworthiness of your business partners, suppliers, and clients to identify potential financial risks. This allows for proactive decision-making regarding business relationships, potentially avoiding issues like late payments or supply disruptions.
- Resolve any negative information on your credit report as soon as possible. These can stay on record for years and significantly impact your score.
- Have a robust credit management strategy to maintain low debt levels. Also be mindful of the frequency of credit applications or inquiries, as multiple inquiries within a short duration can negatively impact creditworthiness.
The role of financial management software in improving your credit score
Financial management software can significantly enhance your efforts to improve your business credit score. Tools such as OneAdvanced’s Financials system can streamline cash flow forecasting and management, leading to better planning and budgeting. It also provides robust credit management functionality, essential for efficient capital management and maintaining a strong credit history.
With real-time reporting, it offers valuable insights around financial performance, allowing you to monitor resource utilisation and maintain optimal financial metrics. With easy access to data linked to cash flow and spending patterns, it reduces the risk of financial mismanagement and missed payments. It also has comprehensive reporting functionality, so that you can offer a clear overview of your financial health to lenders and creditors while enhancing your creditworthiness. Incorporating technologies like Financials into your daily operations can be the first step towards transforming your business's financial health and credit score.