Business Credit Basics

In today’s lending environment, overwhelmingly most of all business loan applications are done based solely on the applicant’s credit score and personal assets. When one considers that working capital is the circulatory system of any business, it becomes clear that without it, a business can simply not function. So it would make sense that even prior to starting your business, you would evaluate exactly how much capital your business will need to function properly.

The simplest way to get this understanding outside of paying an accountant to work up a would be to literally document a day, week, month and quarter of operation your business. Focus on the simple facts that everything you do in regards to your business has a cost. Note I said cost, not additional cost. A prime example is the lemonade stand.

In order to have a lemonade stand, one assumes that the first thing to acquire is lemons, when in actuality, the lemons would be one of the last things to account for. The lemons are the best place to start for this example and as such we will work backwards.

If you squeeze a lemon to start making your lemonade, what will you squeeze it into? So it is clear we will need some vessels not only to make the lemonade, but to also store it and serve it. We will also need a way to clean or dispose of these vessels, a place to store them as well as a place to conduct business. In this one very simple example, we have identified the following items that will have a cost associated to it, these are:

  1. Pitchers (Expense – Small Tools)
  2. Cups (Inventory)
  3. Sink or dishwasher (Fixed Asset – Equipment)
  4. Storage facility (Expense – Rent)
  5. Place to conduct business (Expense – Rent)

All the above have a cost associated with them prior to making your first dollar, as do many other expenditures so when going through the motion of your business day, be aware of everything you do, if you make a phone call, you need a phone. Do you have internet service? A computer? Printer? Paper? Literally walk through the motions and you will be amazed. We use this method in our consulting firm for businesses that want to operate more efficiently or want to expand their current business. The more detail you get into, the more accurate your resulting calculation of needs will be.

Another important fact to remember is that your return on investment is not immediate. An example of this would be dollars spent on advertising need time to take hold before the related sales start flowing in. This means we need to have money to spend prior to it being replaced. A good rule of thumb is to budget for at least three (3) months of reserves. Having the reserves will allow you to focus on the business and not be distracted by minor interruptions in cash-flow.

Now that you have established what your needs will be, you can determine the best path to go forward. It is at this juncture where many small businesses get into trouble. Just because you can demonstrate a need does not mean the bank will be there to meet that need. You have to demonstrate your ability to repay prior to your application, which means you will need some sort of existing credit history for your business. This is where business credit becomes the essential building block on your way to obtaining true working capital loans.

It is very good business acumen to completely separate your business credit from your personal credit. Your personal credit should be viewed as the last resort in obtaining credit, for once that is used, there is no other place to go. The easier it is to identify your personal expenditure from your business expenditures, the easier it will be for a lending institution to loan you solely on behalf of your business entity. It goes without saying that your tax returns will be far simpler to repair as well.

Think of the two types of credit as an inner and outer shell of protection. If you have a problem and need to borrow to fix it, the business credit is the first line of defense. If that is not enough, then you call upon your personal credit, but short of selling assets, that should be seen as your last alternative.