Every business has a credit score, which tells lenders and suppliers how good you are at paying debts. Find out how to use credit scores to your advantage, and how to keep yours healthy.
What does a business credit score say?
A good credit score means that you’re quick to pay bills and debts, so everyone is happier to do business with you:
- Suppliers will probably give you more favourable payment terms.
- Lenders will give you better access to credit and capital.
You can apply the same logic to businesses you deal with. If they have a good credit score, you know they’ll probably pay your invoices on time.
How are business credit scores calculated?
Many companies create credit scores and they each have their own proprietary system for doing it. This means your business will have several credit scores and you won’t really know how any of them were calculated. However there are some basic criteria that are probably used in developing all credit scores.
- Most credit scoring companies are linked to debt collection services, so they know who is and isn’t paying their bills.
- They gather publicly available information about your business from government departments and banks.
- Someone may report you to a credit scoring company if they’re not happy with how fast you pay.
Your credit score might be on a scale of 1–5 or 1–100. The higher your score, the better you are at paying.
Accounting software and credit scores
You can get business credit scores from credit scoring companies and through some accounting software.
It’s a good way to screen businesses before entering a contract with them. If the credit score is really low, you might take steps to protect your business – by either requesting a deposit, giving them shorter payment terms, or declining the business altogether.
You can also punch your own business into the software to see what people are told about your credit rating.
How to get a good business credit score
So how do you improve your business credit score when you don’t really know all the things that go into it? Here are some tips that accountants give to make sure businesses aren’t red-flagged to lenders or other businesses.
Review your business credit score three to four times a year
If it dips, contact the credit scoring company. They’re legally obliged to tell you why. It could be because:
- they made a mistake, in which case you’re entitled to a correction
- a vendor reported you for withholding payments for legitimate reasons like invoice disputes – again, you can get this corrected.
Know what a good business credit score is
Your credit score doesn’t need to be a 4 out of 5, or 75 out of 100 – so don’t stress over a few points here and there. Most businesses will be comfortable working with you so long as you’re not in the bottom quarter.
Pay bills on time
Most of your business credit score will come down to on-time payments.
- Set up a good accounts payable system, so you know when bills are due.
- Use accounting software to automate payments, so you don’t forget.
- Keep an eye on cash flow, so you can see if you’re going to struggle to make payments.
- Be aware that big companies and utilities are more likely to report you for late payment.
Be upfront if you’re having cash flow issues
Every business runs out of money from time to time. If it’s affecting your ability to pay bills, don’t be too proud to call those vendors and explain the situation. They’ll be far less likely to report you to a credit scoring company if you explain:
- why you’ll be running late
- when you’ll be able to pay
How to deal with businesses who have a poor credit score
Credit scores are a two-way street. You can use them to protect your business from bad debts, too. Check out the credit score of clients new and old, and take steps to control risk.
Know what a poor business credit score is
Once you start watching your credit score, you’ll see how hard it is to get a really good one. Try and keep some perspective when reviewing the scores of the businesses you deal with.
- Don’t worry if a business has a middle-of-the-road credit score. Just be wary if they’re in the bottom quarter of the scale.
- If you find that an existing client has a poor credit score, don’t panic. Your personal experience of them counts for more. You only need to worry if their score is trending consistently downward.
Set cautious invoice payment terms for higher-risk businesses
You don’t need to turn down businesses with bad credit scores. You can still do a deal, but you may want to structure the agreement differently.
- Set shorter due dates so you’re not extending them as much credit.
- Ask for an upfront deposit.
- Charge them interest or a late payment processing fee when invoices are past due.
Lower your dependence on late payers
Businesses that consistently pay late will put you under cash flow pressure. They may diminish your ability to pay bills on time, which will affect your credit score. Make sure you’re not over-reliant on businesses that keep you waiting. Gradually try to cycle late-paying clients out of your business.
Take care of your cash flow
So much of your credit score comes down to your cash flow. If you run out of money, you’ll miss payment deadlines and your credit score will get dinged.
You’ll take a lot of pressure off yourself if you make sure you’re getting paid on time. Definitely think about your invoice payment terms and look at how online accounting can help you stay on top of accounts receivable.
And try to be strategic about when you spend money. Consider setting rules around how low you allow your bank balance to get. An accountant can help you decide what makes sense for your business.
Now you know what a business credit score is – look after yours
The maths behind credit scores are complex and mysterious. But the basics of protecting your business credit score are not. Pay your suppliers on time by making sure you keep a reasonable cash reserve in your business. Making sure you get paid on time will help. Good invoicing systems and accounts payable practices are vital to all this.
For original article see: https://www.xero.com/au/resources/small-business-guides/accounting/what-is-a-business-credit-score/