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Understanding how to use commercial credit is essential for a small business’s long-term success. The access to additional capital from a commercial line of credit allows a business owner to maintain and expand the business even in periods of slower cash flow.
This article will cover what commercial credit is, how it works and how to establish it for your company.
What Is Commercial Credit?
Commercial credit is just business credit by another name. It measures a company’s ability to handle its finances and debts over time. If you’re familiar with how personal credit works, then you’ll have no problem grasping the concept of commercial credit.
Commercial credit is also known as business credit or corporate credit. It’s similar to how individuals have a credit report and credit score except it’s for a business instead.
It shows how well a company has historically met its payment obligations with different lenders vendors and other creditors. It does this through business credit reporting agencies such as Dun& Bradstreet, Equifax, and Experian.
These agencies use the information provided by creditors to create a business credit report and develop a business credit score. A good business credit history can help a business qualify for financing in the form of
- Business credit cards
- Lines of credit
- Vendor accounts
So establishing commercial credit for your company is an essential part of running a successful business. If you ask yourself, “What is trade credit?“, then check out our article for more information.
How Does Commercial Credit Work?
Commercial credit has a scoring system the same way personal credit does, but with a few key differences. Business credit scores range from 0 to 100 under Experian and D&B. Other credit reporting agencies have different scoring ranges.
Your score is built on factors that help lenders determine how trustworthy your business is. It includes factors like:
- Payment history
- Industry risk
- Size of the company
- Age of credit history
- Credit utilization
The credit reporting agencies receive information from creditors your business has an account with to form your credit report. If the reported account is in good standing then you’ll see your credit score rise. If the account has a late payment or delinquency you’ll see your score drop.
The higher your business credit score is, the better chances you’ll have at qualifying for credit in the future.
How To Get Commercial Credit
To get commercial credit for your business, you’ll have to have a few things in place but it’s a relatively simple process. It all starts by working with a commercial banking institution to find the most cost-effective lending solutions to fit your business needs.
Once you find the lender you want to work with, you can put in an application. The application asks for basic information such as the name of the company, EIN, name of the owner, etc. The bank will approve the commercial credit application and assign a maximum loan amount or credit limit if the business has favorable financials and a good credit file.
This and other details are outlined in a commercial credit agreement between the bank and the business. This might include the type of revolving credit that’s been issued– secured or unsecured credit.
It’ll also include repayment terms, the interest rate applied to the credit line, and whether or not a personal guarantee is required. You’re probably wondering what the credit, revenue, and time in business requirements are so we’ll cover those soon.
Types of Commercial Credit
There are two types of commercial credit. Secured and unsecured. Each comes with a set of stipulations, but both require different reassurances from the business owner to shield against potential loss from derogatory accounts.
A secured commercial line is a financing option that requires collateral to be submitted as backing for the business line. Collateral usually consists of commercial real estate or large equipment.
If the company isn’t able to repay the amount borrowed, the bank can choose to seize the asset being held as collateral and liquidate it to repay the outstanding debt.
Banks experience less risk with secured lines of credit, so they often come with higher withdrawal limits and lower interest rates.
Unsecured credit isn’t backed by collateral so it’s considered to be a riskier commercial lending option. The bank has limited recourse if the business can’t meet its payment obligation.
To reduce the credit risk associated with it many banks require a personal guarantee. They also offer lower borrowing limits and charge higher interest rates to make up for it.
Requirements for Commercial Credit
Each bank has its own credit and financial requirements that must be met to get credit approval for a commercial line. In general, each bank looks for the following components:
- Time in business
- Annual revenue
- Credit score (business and personal)
The better your business looks in each of these areas makes your business less of a credit risk for the bank. The first stipulation to meet when applying for a credit line is your business and personal credit history.
Even though the credit is for your business, the lender often requires a personal guarantee which makes the business owner responsible for repaying the debt if the business defaults on payments. Typically lenders want a good personal score of 680 and above to qualify.
Your business credit score should also be in the good credit range to get the best approval odds and interest rates. Banking underwriters also look at your time in business. Usually, they like to see at least two years in business.
Revenue requirements typically range from $50,000 to $100,000 annually depending on which bank you go with. During your application process, you’ll likely have to supply documentation like:
- Profit and loss statements
- Balance sheets
- Cash flow statements
This information is used to calculate three financial ratios that determine your ability to repay the granted credit. Your industry is also a determining factor in the decision. If your business is in a high-risk industry, you may have a higher interest rate or lower credit limit.
If your business doesn’t these requirements, you can still get a credit line. You may have to work with an online banking institution or other alternative lenders to get credit. Come prepared to be offered a higher interest rate or stricter terms if your business file isn’t strong enough yet.
Overall, commercial credit is a revolving credit line that allows businesses to handle pressing financial obligations without interrupting cash flow. It may come with a purchasing card for daily business expenses.
Commercial credit lines can be secured or unsecured which can affect the repayment terms of the credit account. It’s important to maintain a solid payment history with a commercial line to build positive credit history and a good relationship with the bank.
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Seychelle is a Maryland-based personal finance writer and business owner. She’s passionate about helping others out of financial pitfalls she’s already dug herself out of. Most of her finance knowledge stems from her career as a Financial Consultant and Branch Manager at the 7th largest US bank. Read more of her work on credit, budgeting, debt consolidation, and entrepreneurship at www.seychellewrites.com