Businesses of all stripes throughout the world are currently facing strong economic headwinds. The precarious situation is worsening by the day as the Federal Reserve raises interest rates after over a decade of a lower-bound interest rate environment. Accordingly, banks will start tightening credit conditions as higher interest rates will reduce consumer demand and push economies into recession.

Over the past decade, the lax credit standards we have been accustomed to will dramatically change. Money will become scarcer, and all these various lending programs and fintech businesses catering to small businesses outside of the banking sector that has thrived for years and have been valued at astronomical unicorn valuations will start floundering. Those that will succeed will have robust processes in place to gauge the creditworthiness of small businesses, determine appropriate lines of credit, and have a centralized reporting mechanism of payment activity.

Fortunately, the opportunity is ripe for such lenders to use the business credit score. Unfortunately, people and businesses are not familiar with business credit scores. Below we explore this number, why companies have credit scores, who calculates these scores, and how they do it. Once we have established an understanding of business credit scores, we look at different steps businesses can take to improve their credit worthiness.

What are Business Credit Scores?

A business credit score gauges the creditworthiness of businesses. It consists of several critical factors that help a lender determine a company’s financial health, the degree of riskiness of its exiting leverage, and how much additional leverage it can bear. The Business credit score can go from 0 to 100, with 100 denoting stellar financial health and the lowest possible risk level and 0 indicating the highest risk level on the spectrum. 

To help in understanding this better, think along the lines of a personal credit score. That is a credit score of up to 850 points that lenders use to determine the creditworthiness of individuals. That figure is then used to determine whether a financial intermediary should offer any credit to a person and at what rate. A higher credit score would mean a low likelihood of the person defaulting on the credit extended or having any issue in timely payback.

Similarly, a business credit score serves the same purpose for the business as a personal credit score serves for the person. It opens doors to lenders and allows for certain expansionary efforts. A good personal credit score will let a person take out a credit card, car, home, or student loan. A good credit score enables businesses to grow their operations by accessing lucrative credit lines among suppliers and financial institutions.

However, it is essential to understand that personal credit scoring and its processes are not identical to those used for businesses. The standardization of personal credit scores is straightforward, although many would successfully argue that an entire industry is focused on helping individuals improve their credit scores. However, for businesses, a variety of factors are used to calculate a business score.

Furthermore, as businesses grow and transform into large corporations that access debt from secondary markets, has a different level of credit evaluation, called credit ratings. Those are not to be confused with a business credit rating.

Finally, privacy is a significant concern for personal credit scores. The only parties with access to individual credit scores are the person and the entity they authorize to access that information. Conversely, for businesses, the business credit score is a matter of public record to which everyone has unfettered access, as long as they are willing to pay for it.

How are credit scores for businesses calculated?

Various factors are all taken into consideration in calculating the business credit score. All three major credit bureaus that calculate the business credit score use these factors, but their methodologies assign different weights to each of them. These factors include;

• Business Credit history – Specifically, this factor evaluates the payment history of a business.
• The Net worth of the owner – This is used to determine the soundness of the management of running the business based on the logic that a higher net worth owner may have access to personal funding as well as access to other sources of funding afforded to high net worth individuals. It also assumes that wealth may have been accumulated by prior successes in the industry or other businesses.

Even payment to certain types of business credit cards that may be difficult to obtain, such as an American Express Business card, paints the business positively.

• How much credit has the business used – an already overindebted company may be a reason for red flags. Credit bureaus will scrutinize not only how much leverage a business has but also the business’s existing relationships with the current lenders.

Who sets credit scores for businesses?

Three major credit bureaus measure and report business credit scores. They are listed below.

1. Dun & Bradstreet – The business credit score at D&B consists of two main scores, the Paydex score, and the Failure score.

• The Paydex score – ranges from 0 to 100 and is determined by a business’s payment history to its vendors and suppliers. A company must obtain a D-U-N-S number to have a Paydex score. A business must make the application with D&B and have at least four vendors reporting to D&B.
• The Failure score – also referred to as the Financial Stress Score in the past, is a ranking on a scale of 1 – 5 determined by the financial stress a business is likely to encounter. Financial stress is determined by the owner’s net worth, how long a company has been in business, and the history of lawsuits filed against it.

1. Equifax – this credit bureau has scores on which it gauges businesses to determine the business credit score.

• The payment Index – a score of 1-100 is assigned based on a business’s payment history.
• The Credit Risk – a score of 101-992 is assigned based on a likelihood of default based on the business size, age, current lines of credit, and history of past missed payments.
• The Business Failure Score – a score of 1000-1610 based on how often the business maxed out their credit lines and the history of late payments.

1. Experian – this credit bureau has only one score, from 0-100, known as the credit score. It looks at the same metrics the other two credit bureaus do but also looks at additional factors such as public records on the business.

Why should a business have a credit score or even a credit history?

There are several reasons that business will require a good credit history. Simply saying that if a company has no credit history and not a bad one will not suffice. There are third parties that businesses interact with and service, which will require a well-established credit history. Below are some examples of such scenarios:

• A bank will require an established credit history and a good business credit score not only to issue a loan to a business but offer it at a prime rate. This applies not only to bank loans but the financing of any type, such as vehicle financing, equipment financing, signing a lease on an office location, etc.
• If a business does not have a strong credit history, the owners will be required to secure any lines of credit or loans with their personal assets. Not only will this encumber personal assets that can be used for other purposes, but there is also the added stress of personal assets such as a car or a home put at stake in the event the business cannot repay the loan.
• Furthermore, personally signing for business loans will directly impact the owner’s personal credit score. If a business and personal account are used interchangeably, business and personal credit scores can also be entangled. They are again adding to the stress and the risk of not having a solid business credit history.

How do I build a good credit score for my business?

Let’s look at ways businesses can build a strong credit score. Merchants can start by establishing an excellent credit history. Whether a merchant is starting from scratch or trying to reverse a poor credit profile, there are specific measures they can take to improve their odds of developing a high business credit score.

Business registration – The first step is to register the business. That would mean that a merchant would have to do a name search and get a lawyer or a service to write and file their Articles of Association for the business with the state’s treasury department. There is also a requirement to file for an Employer Identification Number (EIN), often interchangeable with a Tax Identification Number (TIN). Once you obtain this information, you can use this to set up a business credit score with any of the business credit scoring agencies. This isn’t that different from a social security number used to track a personal credit score.

Get a bank account for your business – the business should have a separate bank account from the person so that business assets and transactions can be easily gauged. It also lends credence to the professionalism of a business rather than it being considered a personal fiefdom of the business owner.

Make timely payments – simply put, pay everything on time, if not well in advance, so there is never even a possibility of late payment. This is an absolute must. Missed and late payments cast a very dark shadow on a business – if it cannot pay a utility bill on time, how can it pay a bank loan in a timely fashion?!

On the flip side, timely payments showcase the strength of business operations, the financial health, and overall reasonable prudence and fiduciary responsibility by the owners.

Get a D-U-N-S number – many suppliers and lending institutions will automatically ask for this number. So it is imperative that merchants immediately set up a D-U-N-S number once the business registration is complete and a business bank account is set up. This will allow them to quickly set up their Paydex score and share this information with their suppliers and vendors.

Regularly gauge Business Credit Scores – It is advised that individuals should periodically monitor their personal credit scores to keep an eye out on any anomalies, or god forbid, something more nefarious. Similarly, businesses should do so as well, again going back to what gets measured, gets done. Companies should look out for errors or omissions on their business credit scores and see how their score has progressed over a year to focus on what to continue doing and what actions to refrain from.

Businesses of all kinds have a pejorative to establish a tremendous financial health score. The best way to do that is to have a strong business credit score. Like a personal credit score, the mere fact that merchants are paying attention to this number presents an opportunity for the will and focus on diverting energies to improve the figure. That which gets measured gets done!

The economic environment has shifted, and more and more businesses have started to feel the pinch of inflation, rising interest rates, and rising labor costs. If enterprises do international trading, they’ve felt the pinch of a strong US dollar.

In this environment, it is pertinent that merchants have a strong understanding of a business credit score, how it manages this number, and the various factors used in its calculation. As economic conditions further deteriorate, this understanding and preparation for improving this number are likely to provide a financial lifeline, especially the lender themselves start feeling the impact of recessionary headwinds.