If you own a small business, you already know how important it is to maintain good credit standing for your company. Business creditworthiness is measured in large part by reports issued by credit bureaus such as Dun & Bradstreet, Experian, and others; lending institutions and others use these reports to gauge how risky it might be doing business with your firm, whether lending you money, extending credit, purchasing goods or services, or engaging in some other transaction. However, if your company does not have longstanding credit or is new to market, lending institutions in particular might examine the personal credit report of the business owner, or other partners or principals in the company. If a company’s principals can’t keep their personal finances in order, that does not bode well for how their company’s finances may fare over time, at least in the eyes of a potential lender.
For this reason, it’s important to keep your personal credit history in good order too. In the United States, there are three national credit bureaus that collect personal financial data and compile reports: Experian, Equifax, and TransUnion. All three companies operate in similar fashion; Experian and Equifax have extensive business credit report divisions as well. And all three process the data they collect, generating the all-important FICO score.
FICO stands for Fair Isaac Company, which was formed in 1956 by the engineer Bill Fair and the mathematician Earl Isaac. The company devised a credit scoring system, which it eventually sold to the three major U.S. credit bureaus as well as bureaus abroad. Each of the credit bureaus assigned its own name to the scoring system (Experian, “Fair Isaac Risk Model”; Equifax, “Beacon”; and TransUnion, “Empirica”), but the score is still universally known as a FICO score.
A FICO score can range from 300 to 850; the higher the number, the better the creditworthiness. The exact formula is confidential, but various factors go into the calculation, as follows: 35 percent, payment history (whether you have a history of late payments); 30 percent, credit utilization (the ratio of revolving debt to total available revolving credit — a lower ratio is better); 15 percent, length of credit history (the longer, the better); 10 percent, types of credit used (using various types of credit is a positive); and 10 percent, recent credit inquiries (which, if excessive, can hurt your score).
It should be pointed out that Fair Isaac does not calculate individual scores; the three credit bureaus do that. And because the data collected by the three bureaus can differ, the scores generated by each will differ as well. If you are monitoring your FICO score (and you should, on at least an annual basis), you must get your score from each of the three bureaus and ensure that each one is accurate and up-to-date. If any of the three scores is far off from the other two, there is probably an error or oversight.
Lending institutions can interpret FICO scores however they wish; the score is a universal guideline, not a binding measurement. Because a FICO score is a measure of risk — how risky it would be loaning money to the individual owning the score — interest rates on loans will be higher for people with lower scores. For instance, an individual with a FICO score of 775 may qualify for a personal loan at 4.25 percent, whereas an individual with a score of only 625 may be offered only 5.85 percent. Over the course of a long-term loan, a bad FICO score can cost you a lot of money in interest payments.
With respect to a small business, lenders will often examine both a Dun & Bradstreet business credit report (including the company’s Paydex score, which calibrates how closely the firm adheres to payment terms on outstanding invoices), and the business owner’s FICO score from one of the three credit bureaus. Most commercial lenders like to see FICO scores of 650 or 700 and above, although commercial lenders consider dozens of variables. A high FICO score will not necessarily qualify you for a loan, just as a low FICO score will not automatically disqualify you.
There is much that you can do, as an individual, to improve your FICO score. Most importantly, pay your bills on time. Reduce outstanding debt as much as possible. Keep outstanding credit card debt at less than 30 percent of your credit limit. It’s not necessarily bad to have several credit cards with outstanding balances, but keep the balances low and manageable, continuing to use the cards nonextravagantly. And try to keep the number of credit inquiries at a minimum. Each time you apply for credit, the lender will check your report, and this access is monitored. The more inquiries into your credit, the lower your score will be.
Check your credit reports at each of the three bureaus at least annually. Each of the bureaus is required by law to provide you with your full credit report free of charge once a year, so you can check your FICO score every four months, alternating among the three bureaus. If you see a major error in one report, you may wish to purchase reports from the other two bureaus immediately thereafter to ensure that all three are corrected as necessary. And bear in mind, of course, that your three FICO scores at each of the three agencies will differ, hopefully just slightly.
If you maintain a good FICO score, and strong personal creditworthiness, you will be doing your business a big favor.