SPEND RESPONSIBLY

Managing credit for small business

Responsible borrowing

Look after your credit ratings

Business and personal credit ratings...both are important.

One of the most important things to remember when financing your business is the importance of maintaining a good credit rating – both for yourself and your business. Credit ratings are compiled by credit bureaus, which collect information on how you have managed credit in the past.

Just one missed payment can affect your credit rating, making it harder to secure low-cost credit from the lender of your choice. That’s why it’s important to maintain a healthy credit bureau file, and you can do this by making sure business payments are made on time, keeping good records and following proper planning and budgeting procedures.

Your business credit rating

Most businesses are given a credit rating by credit bureau - Dun & Bradstreet (D&B). A company that has been rated receives a “D-U-N-S Number”, which may be used by a number of parties including trade creditors to determine payment terms, by lenders to determine interest rates, or by insurance companies to determine your premiums. This makes your D&B rating very important.

It is possible to get a copy of your credit profile with D&B. This gives you an insight into the way creditors, lenders and other providers of credit will see your business. For more on how you can check your current profile, log onto D&B’s website at www.dnb.com.au.

Always borrow responsibly

Credit can be the lifeblood of a small business but it can also be a cause of business failure if credit is used unwisely.

Here are some tips for effectively using and managing credit in your business:

It is vitally important to keep track of what you owe on credit cards, bank loans, mortgages and any other debt. Good records help you make sure that you don’t take on more debt than you can comfortably repay.

The best way to separate business and personal expenses is to get a credit card and credit lines that are only used for business purposes. This will also make things easier at tax time.

Keep careful tabs on your business debts - especially high interest credit card debt. Make sure that your debt stays within manageable levels relative to your overall assets and cash.

Careful use of credit requires accurate budgeting. Taking on more debt usually means paying higher monthly repayments, and proper budgeting will help you anticipate and plan your monthly payments.

Be careful to shop around for credit cards, loans and other debt facilities to get the lowest possible interest rates. This reduces the cost of credit and helps keep your payments within manageable limits.

Late payments will not only damage your credit rating, they can also put you in default on some types of loans. This will limit your choice of lenders in the future, potentially cause your cost of borrowing to soar. To avoid these problems, always make payments on time.

Sources of credit

Business credit cards

Credit cards are a popular source of credit for small businesses. They are a quick and simple form of finance – and one that we are all familiar with. But they must be used with care to protect the financial well-being of your business.

It is a good idea to use a separate business credit card – rather than using your personal card for business expenses. Using a business credit card lets you identify business expenditure, collect quarterly and annual statements for tax reporting, and access business-sized credit limits. Many business credit cards also provide additional benefits including reward programs with points that can be redeemed for travel and other items your company may need.

Speak with your bank

If you qualify, borrowing from a bank may be your best business finance option. When you apply for credit, banks will look for a number of things including a sound financial history, a successful business track record, well-maintained records and a healthy credit bureau file.

Before applying for finance, it’s important to have your financial statements - both personal and business, in order. Having the required information on hand can streamline your finance application.

Making numerous applications to different lending institutions isn’t a good idea as it can affect your credit rating. Instead of making multiple credit applications, shop around to find the lenders whose terms suit your business best, then limit your applications to just one or two of these.

Equipment leasing

Small businesses don’t always have the financial resources to buy the equipment they need. Even when they do, it may not be the best use of business capital. A better alternative may be equipment leasing, which can be cheaper - and easier on your cashflow.

In a finance lease, for example, your lender buys the asset, then leases it back to you for an agreed period. Instead of paying a large lump sum to purchase the equipment, you pay a far smaller monthly lease fee. This frees up cash for use in other areas of the business, and, because you can upgrade your equipment on a regular basis, your business is able to keep abreast with changes in technology.

Trade finance

Business suppliers can be an important source of credit. Known as ‘trade credit’, your suppliers may specify payment terms like thirty, sixty or even ninety days for payment of their invoices. This means your supplier is giving you an interest-free period in which you can generate revenue from the supplies. It’s a good deal for all businesses, so it is worth protecting your credit reputation among your suppliers.

Building a healthy repayment reputation may mean some suppliers extend their payment terms. Conversely, if you fail to meet the terms of your trade credit, suppliers may start asking for cash payments.

Unlock your debtors

Trade debtors can be a valuable source of business finance. Also known as ‘receivables’, debtors are customers of your business which you have extended credit to. But they can also be a source of funding called ‘factoring’. This is when you ‘sell’ your receivable to a lender called a ‘factor’.

A factor accepts your debtors as collateral and then lends you a certain percentage of their value. The factor pays you in advance for these invoices, letting you generate cash sooner than if you collected the money on your own. Factoring can also let you save on costs associated with late payments and chasing up bad debts.

Of course, the advantages of factoring come at cost. You won’t receive the full value of your debtors, and there may be other associated fees. In addition, most factors require that you turn over all of your receivables to them—even those who pay on time. This could adversely affect your customer relations, so it’s a matter you should give some thought to. For instance by using a factor, you may not be able to give preferred customers extended payment terms in order to encourage future loyalty.

Friends and family

Friends and family have always been a potential source of start-up capital. It may be a convenient and inexpensive option, with the added advantage that friends and family don’t usually look for the same level of documentation and track record that conventional lenders ask for. But there are downsides.

Emotional connections may complicate the financial transaction, and the friends or family involved may want a say in how the business is run. And if the business fails or you cannot meet repayments, there may be personal as well as financial consequences. So it is worth seeking legal advice and having any terms you agree upon drawn up in a written contract.