Entrepreneurs often use their personal credit in the startup phase of a new business. This is sometimes done out of necessity, as traditional banks and credit unions don’t extend business credit until the company has been established for a while. In this article, we’ll explain how to avoid that problem.
What you need to know
- Personal credit score is calculated using factors like payment history, credit utilization, credit history, credit mix, and new credit accounts.
- Business credit score is calculated using factors like payment history, credit history, credit/debt usage, company size, and industry risk.
- Personal credit score uses a scale of 300–850, while business credit score uses a scale of 0–100. Both give a picture of your creditworthiness.
What is personal credit?
Personal credit is a term used to describe how you manage personal debt. That includes credit cards, personal loans, lines of credit, auto loans, and mortgages. Your payments on each of these are monitored by personal credit bureaus that feed information to companies, like FICO®, that calculate your personal credit score—a measure of your creditworthiness.
Credit bureaus like Experian, Equifax, and TransUnion then keep track of your individual credit history and publish credit reports that you can access. Lenders use your score (during a soft credit check) and these full reports (during a hard credit check, which can impact your score) to assess risk and decide if you can borrow more money.
To get your credit score, calculations are done using five primary data categories:
· Payment history: Tracks whether you pay your bills on time. This is the most important category in credit scoring. It counts as 35% of your overall credit score.
· Amounts owed: Tracks your personal credit utilization, which is how much you owe compared to your credit limits. This is worth 30% of your overall credit score.
· Length of credit history: This category keeps track of your credit history, so never close your oldest account. This is worth 15% of your score.
· Credit mix: A healthy mix is having a personal loan, a credit card, an auto loan, and a mortgage. A good mix is an indicator of maturity. This is worth 10% of your score.
· New credit: Number of new accounts shows up here. It’s worth 10% of your score. Understanding the categories can help you monitor and improve your personal credit. This is important when you go to buy a car or apply for a home loan. Individuals with good credit get better terms and lower interest rates. Using your personal credit for your business could put that at risk. We’ll explain more about that later.
What is business credit?
Your company can have a business credit score and credit reports unrelated to your personal credit score. Business credit reports are produced by Dun & Bradstreet, Equifax Business, or Experian Business, and the variables used to calculate your business credit scores are different from those used to calculate your personal score. They include:
- Your business’s payment history
- Age of business credit history
- Business debt usage
- Industry risk
- Company size
Registered businesses and corporations also have employer identification numbers (EIN), which are attached to your credit in place of your social security number. You’ll also want to register with Dun & Bradstreet to receive a DUNS number. They won’t start tracking your business credit activity if you’re not in their system.
Once you have your EIN and your DUNS, you can apply for some type of business debt. That could be a business credit card or business loan. The three business credit bureaus will track your payments to build your business credit history. The length of that history and the timeliness of your payments on debt accounts will be used to calculate your business credit score.
Unlike personal scores done by FICO—which use a scale of 300 to 850—Dun & Bradstreet scores businesses on a scale of 0 to 100. They both track credit activity, but D&B also tracks business trade lines, or credit issued to businesses from their vendors. That’s one of several credit report differences you’ll see from business credit bureaus.
Business debt management may also be done differently than personal debt management because businesses have a variable income stream. Individuals often rely on a fixed salary, so they can budget debt payments easily. Business owners must be more cautious when taking on debt because market conditions and economic downturns could affect revenue.
Why building business credit is important
One of the most difficult tasks for new business owners is separating business finances from personal finances. This is particularly true when the business struggles. Your first instinct might be to put more of your own money into it, but keeping your personal and business finances intermingled could put your home or other personal assets at risk.
Building business credit can protect your personal assets from business liabilities—including legal liability. A corporation or LLC is responsible for its own debts, and will not affect the owner’s credit rating if they were taken out under the corporate EIN.
Don’t underestimate the impact of your credit rating on your business. The business credit bureaus track credit utilization that can be used for credit risk assessment. Simple actions like paying your business credit card bills on time could lead to better financing opportunities in the future. Lenders, creditors, suppliers, vendors, and potential partners or investors will look at the factors that make up your business credit, so a good business credit score could be the key to future growth.
Need more convincing? Try looking at the differences in available credit when assessing business loans vs personal loans. Established companies can borrow more and get better terms than individuals with great personal credit scores.
Finally, your business credit is important to building credibility and financial independence. Put the same effort into improving it as you do your personal credit, and you’ll eventually have a business that stands on its own.
The future of business credit
Credit score factors aren’t likely to change much, but technology is changing how we borrow money and manage debt. Blockchain has made processing and loan approvals faster, often cutting out third-party processors that charge expensive fees. Look for more on that in the near future—the technology is evolving rapidly.
Another change to watch out for is the role of digital assets in business credit reporting. Many companies are investing in crypto and NFTs because of their growth potential. Unfortunately, there’s also significant risk in those investments. D&B uses balance sheets in their business credit analysis, so risky digital assets could lower your business credit score.
If you take one thing away from this article, let it be this: personal credit and business credit should be kept separate. Register your business with Dun & Bradstreet, check for a business credit rating at Experian and Equifax, and start building your business credit profile with credit cards, loans, or lines of credit.
Add flexibility to your cash flow with a business line of credit.
