The process of assessing business credit risk differs slightly from the decision-making process when it comes to personal credit. All banks and leasing companies use their own reports and scoring models, which adds troublesome variables to the process. In essence, however, the lending company simply wants to know how well the business handles its debt.
According to experts, there are five key factors that have an impact on business credit:
- Credit capacity
- Capital invested
- Company conditions
The first, creditworthiness, is fairly self-explanatory. Both the personal credit report of the owner and the commercial credit report of the business are assessed to determine whether any existing debts are being paid in a timely fashion.
Credit capacity is an extension of creditworthiness, with the cash flow of the business undergoing a thorough examination. This helps the lenders assess how much more credit the borrower can realistically repay in a given period.
Collateral, likewise, is easily explained: Any inventory, business equipment, or commercial real estate is offered as repayment if the borrower fails to live up to his end of the bargain. The loan-to-value ratio of the collateral is determined on an individual basis by the lending company. It should be noted that while the majority of traditional banks require collateral in case of default, there are other companies that do not have this requirement.
The bank will also examine the capital invested, to determine whether this further investment—undertaken by the lender itself—is worth the risk. If the owner has already invested a tidy sum in the business, the bank is more likely to sit up and take notice.
Finally, company conditions play a subtle but important role in the lending decision. The competitiveness of the business, its history, the owner’s background and experience—all of these are factors that the bank will take into consideration. To put it in layman’s terms, no one wants to bet on a lame horse. Lending institutions are no different.
One factor that’s less quantifiable, but easily attainable: Foster positive relationships with area banks and credit unions. It’s far easier to obtain credit from a company that has an established history with the applicant, so maintain a healthy account balance or two for a good period of time before applying for a business loan. It’s also important to maintain good communication with your local banks and credit unions and other types of lenders. It makes handling any issues that arise in the future easier if you have a good relationship with your lender.