With so many things going on at the start of a business, new entrepreneurs often shrug off establishing business credit as they think it to be of less importance compared to other urgent matters, such as hiring of employees, marketing their products and making actual sales. But establishing business credit is just as important as those other activities. Why? Because it is a valuable asset that could come in handy when your business needs it most.
How is business credit an asset, you ask? I’ll tell you how. Investopedia defines an asset as a resource with economic value that either you or your business controls with the expectation of benefiting from it in the future. They further break it down and tell you to think of it as something that can generate cash flow. (Source: http://www.investopedia.com/terms/a/asset.asp). Business credit creates an asset that your company can use to acquire financing. That it is why you should view and treat it with the same importance as your other intangible assets such as patents, account receivables and copyrights.
A lot of people put off establishing business credit because they have personal credit they can use for their businesses. This is a huge mistake. Your business should have its own line of credit independent of its owner. This is why:
- To protect personal credit. Using your personal credit for your business is not an issue when the business is doing well. But what if it goes through a financial dip – which could happen to any business – and it’s unable to settle its debts for which you are liable? That debt will be reflected on your personal credit, and in extreme cases the lender will come after your personal assets to settle their debt. This is why separating the two lines of credit is important.
- Larger credit capacity. A business can have as much as 100 times greater credit capacity compared to personal credit. Once your business has developed its own credit, it will be in a position to qualify for financing based only on factors related to the business.
- It’s a safety net for your business. All business go through hard financial times at one point or another. Cash flow drops to the negative and the company is unable to meet its short-term With well-established business credit, your company will be able to access funds to deal with the financial bind.
- Increased company value. Since business credit is an asset, it is fully transferable with the company if you decide to sell. The value of your business can significantly increase when your business credit is good.
So now that we have determined that establishing credit is important for your business, what are the things that you need to consider before you begin? Before establishing business credit for your company, there are three main things you need to consider:
- Can you afford it? Do not assume that your business can afford to use credit just because credit has been granted. Credit is not free, it comes at a cost so you need to evaluate your company’s situation carefully to determine whether it is affordable.
- The spending patterns of your business. How do you intend to use your company’s credit? Will you be paying the balance owed every month or will you be carrying it month to month? Are you planning on using your business’ credit for day to day purchases, or for unforeseen expenses only? If you plan on paying your statements and invoices every month, then interest rates are not of importance. Look for credit with a long grace period and no annual fees. If you will be carrying the balance forward, look for the lowest rate possible. For day to day transactions, you will need credit with sizable limits and low rates. Whichever option you choose, make sure your payment activities are reported to your business’ credit files.
- Interest rates and terms. Pay close attention to the annual percentage rates, also known as the APR. Most credit card issuers will offer a low introductory rate to attract customers and then adjust it upwards after the end of the introductory period.
By establishing business credit for your company, lenders, banks, and suppliers will be able to assess your company’s creditworthiness. This will enable your company to maximise its funding potential and credit capacity.