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CORPORATE CREDIT FOR BUSINESS:
EXTENDING CREDIT TO A NEW BUSINESS
Start-up businesses are constantly being established these days. Your business may be receiving credit applications from these brand new companies. They can be well-established with excellent funding backing them up and good management practices in place. On the other hand, they can be in debt up to their ears with a terrible administration. So there is a great deal of risk on your part in extending these start-ups credit if they have little history or few credit references. However, there are methods to help determine who is a good risk and who isn’t for your company to take on.
Having your customer obtain a letter of credit from their bank is a good method to make sure you will be paid for your company’s goods or services. This puts the responsibility of paying you on the customer’s bank in case the customer defaults. As with all financial arrangements, take the time and effort to carefully review the letter of credit to safeguard your company in its use.
Another way to protect yourself as creditor is to become a secured creditor. This is when you require some collateral from the customer to offset the liability of the credit you are extending him. By pledging certain assets, the borrower is putting himself on the spot to either pay for what is received on credit, or risk losing those assets. As the creditor, your risk is reduced by the value of the assets offered to secure the credit.
Credit insurance is one of the easiest ways to cover potential losses when extending credit to a new business. The insurance company will cover the debt in the event that the customer defaults on it. Like all insurances, credit insurance does have a deductible and a cap on the amount of losses it will pay out. Depending on the borrower, it may be difficult to acquire.
You can also form a consignment agreement with the business that desires credit. Ownership of the good does not belong to the borrower until they actually sell that good. This way the borrower cannot default on the payment since they do not actually own the product. If they are not able to use that particular good, it is returned to the company that sold it to them.
Personal guarantees can be required by the owners or directors of the borrowing company. These will lower the risk of the credit because the individuals are personally responsible for the payment. These are not easy to obtain and you have to ensure the financial resources of the individuals who are making the guarantees.
There are times where having a profit sharing agreement with the borrower can be enacted if the borrower is simply reselling your product. In this arrangement you just pay a commission to the borrower for each sale they make of your product.
FINANCIAL RATIO ANALYSIS
Financial analysis is important for any business to understand how effective it is in its operations. Figuring out what a company is doing is not possible just by looking at some figures. A financial ratio analysis is needed to define the effectiveness of a company’s management decisions and performance. This type of analysis goes a long way in determining if a firm will succeed or fail and how it fares against the competition. A company can use a financial ratio analysis to detect where it may need help and make a course correction before failure. Here are examples of these ratios.
The profitability ratios look at a firm’s success in realizing a profit and taking into account their margins and expenses. A better result indicates more profit.
· Gross profit margin-this is the percentage of revenue that remains after figuring out the cost of goods sold
· Net profit margin- measures what percentage of revenue a company receives that becomes net income.
· Return on Equity- indicates the amount of profit that is realized from shareholders’ capital investment.
Operating Ratios shows the company’s organizational and management efficiency compared to the firm’s expenses, sales, and profit.
· Asset turnover- revenue produced for each dollar of asset that shows on the company’s balance sheet.
· Inventory turnover- how often a firm’s inventory is sold and replaced in a given time frame.
Liquidity Ratios show how easily a business can meet their short-term liabilities on-time. Investors like this ratio in trying to figure out how quickly they can realize a return on capital if a problem occurs.
· Current ratio- how fast short-term commitments can be met.
· Quick ratio- how fast short-term commitments can be met without the liquidation of stock.
Debt ratios match a firm’s debt with its assets and equity to illustrate how leveraged a business is and its ability to pay debt and interest.
· Debt ratio- the total debt a company has in its relation to its assets. This determines the leveraged amount.
· Interest coverage ratio- illustrates how easy a business can pay the interest on its debt.
· Debt service coverage ratio- shows the available cash to pay principle and interest payments on a company’s loans as well as on lease payments.
Cash flow ratios indicate a firm’s capacity to produce and manage cash flow from company operations.
· Operating cash flow ratio- shows how current liabilities are covered by the cash flow of the business.
· Price/cash flow ratio- this compares the business’ share price to the cash flow created on a per share basis
· Cash flow margin ratio- indicates the company’s success at turning sales into cash.
These all help calculate the possible success or failure of a business enterprise. They offer certain key indicators of where a company may need to improve in their business operations. These ratios are not something that are done as a one and done type of thing. They have to be continually monitored to keep track of the financial viability of the business.
HOW TO DEAL WITH CREDIT FRAUD IN BUSINESS
As credit fraud is an increasing concern in business, the chances of falling victim to this type of fraud is 3 times more likely than even a decade ago. Statistics show that credit fraud is more likely to happen to a small business than a large firm.
There are instances of a company trying to piggyback on the good name and credit of another company, in order to purchase goods or supplies for themselves, but in the other company’s name. A company may also “tweak” the data they show to a business they are trying to arrange credit with to put themselves in a better light, in the hope that the credit will be offered. The bottom line is before a company does extend any type of credit, it needs to be meticulous in how it arrives at its decision to offer credit. There are different measures a company can take to make sure it is doing its best to arrive at good credit decisions. We are going to look at some of them now to help safeguard your business.
Due diligence is imperative on the part of the company offering credit to successfully weed out potential frauds. A company must review all references, background checks, and credit reports that relate to the business requesting credit terms. These procedures are routine. One of the first signs that you may be dealing with a company that isn’t what they claim to be is when these checks become difficult to verify. It is also important to make sure that the company you are checking out matches the company requesting credit. Outright company fraud is becoming more common place. These procedures may take time on your firm’s part, but they will save you a ton of money if always conducted properly.
Beware of the Signs
It is not always easy to identify possible fraud but there are definite indicators to be aware of. And the more you do this, the easier they are to spot. Some obvious signs may be when a new customer requests a large order overnight. It is best to start out small with a new customer when extending credit to them. On products with a large price tag, if a customer doesn’t try to bargain with you, it may indicate that they have no intention of paying at all.
You cannot have a 100% success rate against fraud. But by doing your best to do due diligence, checking all the facts, and being constantly aware of your customers, you can greatly reduce your vulnerability to fraud.
HOW TO FILL OUT A CREDIT APPLICATION
Most business owners begin their companies using personal money they have saved up or using what personal credit they have access to. While this may be acceptable to the business owner, it is full of risk. It is worthwhile to investigate other means of obtaining financing for the company. Banks aren’t all that anxious to lend money to small businesses, but it doesn’t hurt to approach them to obtain a loan in the name of the business. It is good to understand how to fill out a business credit application.
An application will require you to fill out the basics like the name of the business, address, phone number, e-mail address, etc. It will also ask what type of company you are: a sole proprietorship, partnership, LLC, etc. It is a good idea to change the structure of your business to reduce liability and tax payments. Then you will be asked to describe your business. You will have to indicate how your business falls into the NAICS code (North American Industry Classification System). You can go to www.naics.com to understand this system and to determine how to classify your business. The lender will want to know what type of products and/or services your company provides to produce revenue. They will want to know the markets your company deals in and the type of customer you attract.
Then you will be asked for your company’s financial information. They want to know the banks your business deals with, the account records, profit and loss statements, balance sheets, etc. It is important to be specific with the current and historical figures of the business as opposed to estimates. Also part of this information is amount of inventory, employees on the payroll, company assets and debt, etc. Be honest in all figures that are asked for.
The lending institution will inquire if you have collateral to put up against the loan or if some entity will guarantee it. This will have a big effect on loan approval depending on the credit strength of the guarantor or the value of the collateral. In this instance it is a great idea to bring a financial advisor into the mix to help you determine the best way to secure the loan you are requesting.
Often three years of past tax records will be requested in the loan process. This also applies for any guarantor of the loan as well. Add three years of balance sheets and financial statements for the business as well as projections on the company’s performance if the loan is approved.
There may also be questions that need answering that apply to state and/or federal laws. As with everything else, be honest in your answers. Remember to review and check all of the information that you put down on the application or submit with it. Don’t forget anything that is requested. Do not forget to sign the application!
HOW TO IMPROVE YOUR DNB REPORT
When you register your business with Dun and Bradstreet, they will issue you a DUNS number. This is how your business is identified among all of the businesses in the D&B data bank. Once you have a credit file in the D&B credit bureau and other companies report on you within it, the information on your firm will grow in determining your credit and financial strength against other businesses in the same industry. In the beginning you may not be happy with your report, but we are going to look at ways to bring about improvement.
This is an indicator of payment performance based on your company’s history as reported by trade references. This will begin as soon as you have at least four payment experiences on file. The Paydex ranges from 0-100. If you have a score of 80 or above this shows that your company has a low risk of not paying promptly. A medium risk is a business that pays with a month’s terms and is indicated by a score between 70-50. A high risk is a score of 40-20 and shows the company pays within 2-4 months. Below 19 is an extreme risk. This score can be improved by first making sure that the information is accurate. Of course, making every effort to pay the bills on time will increase your score. Paydex is a strong indicator of a company’s ability to pay since it looks at a company’s history over time. The Paydex score enables a company to predict when it will be paid by another business by looking at that business’ score. The D&B is not perfect. It weighs scores in favor of the amounts of money in a transaction. The bigger the transaction, the more it is favored. A company can have four late payments of $100 each, but that is wiped out with one on-time payment to a vendor of $20,000. You can also argue bad trade references on your report with D&B.
A trade reference does have a certain amount of time to refute a claim, but this rarely happens. So a poor reference can be removed from a company’s records and then boost its Paydex score. You can see how some companies could use this feature to make themselves seem more credit-worthy than what the reality is. It is a good idea to review the rest of a company’s credit history and not to simply rely on the Paydex score. It is one factor to look at, but should not be the only one. Since you want your business to perform well within its particular industry, it is a good idea not to participate in any practices where you try to manipulate your Paydex score. Make sure your accounts match those listed by vendors and only argue the claims where you can show that they are in error. A business consultant can prove invaluable in helping you to manage your credit profile properly.
Commercial Credit Score
This score indicates the probability that a firm will pay its delinquent bills in a certain time frame, satisfy creditors, and be able to pay its debts within a year of claiming insolvency. They are like a credit score but the scale is between 0-670 with a higher score being better. A business is also assigned a certain class that goes from 1-5 with 1 being excellent and going down from there. In order to beef up your commercial credit score, try adding more payment experiences to your profile and lowering the ratio of poor credit experiences to good ones.
Like the Paydex score, manipulation of the commercial credit score can also be accomplished. They both use similar type of information. A manipulated score can dupe creditors to extend credit based on bogus information. Here is another case where a creditor needs to rely on all types of information to determine if a customer is eligible for credit, and not just one factor. Make sure you are contacting references to verify information that you see in reports.
Financial Stress Score
This score relates to a company’s ability to secure legal assistance against creditors in case of default. The score takes in account a firm’s financial records, their performance ratios, and other public data. These are broken into classes from 1 to 5 (1 being the best and 5 the worse) and the score scale goes from 1000 to 1875. A company can improve their stress score by taking care of any legal matters or judgments that are open. The score can also improve by strengthening the company’s financials. A good payment track record also bumps up a company’s score. The integrity of this score is good since it gathers data from public files which are difficult to fabricate.
Supplier Evaluation Risk
This score relates to a company’s ability to avoid supply issues within a year’s time frame. This scale goes from 1-9 with the 9 being the highest risk of experiencing a supply failure. This score can also be improved by taking pains to make sure that all payments that a company has to make are done on time. Eliminate all judgments or liens that have been made against the business. Having the company demonstrate a solid profit will also improve the scores. A company may have a good Paydex score and commercial credit score, but if it is behind in paying its major vendors, that issue will show up in the supplier evaluation risk. Basically it comes down to the fact that if a business shows consistency in paying its vendors on time, this score will be stellar.
Credit Limit Recommendation
D&B recommends through its credit limit the amount of credit a business can take on. The scale goes from a minimal amount of credit to the max that a company can responsibly absorb.
The last, but certainly not least, report we come to is the credit report. This report includes a concise financial statement of the company and shows its assets and liabilities. This gives potential lenders a snapshot of what a company’s financial situation is in order to make a decision on issuing credit.
Looking at the above example, the strengths and weaknesses of the company is shown. The weaknesses are something the business can definitely work on to improve their credit score. The Paydex score illustrates an excellent track record of payments as reported by its trade references. Its credit score is not perfect but still is a respectable 451. These scores are good but they are still only better than 70-80% of the business world. The credit score can be improved by paying off the company’s debt quicker or by lowering the amount that is owed. The downside of this report is the company’s 1421 financial stress score. Because the business is dealing with several outstanding lawsuits and has a deficiency of working capital, the financial stress score shows that this firm is only 23% better that the competition. This company needs to get those lawsuits put to bed and improve cash flow and come up with more working capital to improve the score. It is also apparent that the lawsuits stem from not paying the company’s vendors since the supplier evaluation risk rating is terrible. When a company is in an industry that has a limited amount of suppliers like this one, the danger is compounded when you receive a bad rating from any of them. And if a firm gets a bad report from the suppliers it is going to be difficult to turn things around. So the company really needs to resolve the issues they have about their payments.
With a debt ratio of 4.875, an investor can see that this company is highly leveraged and will be a risk. The company can make efforts to improve this ratio by restructuring its equity financing and taking steps to reduce the company debt. On the plus side, the current ratio of 3.75, demonstrates that this company can meet its short-term liabilities without a problem. While there are many areas this company can improve on, overall it is in fairly good shape. Because of a good Paydex score, financial stress score, and commercial credit score, this company should not have too much problem in obtaining credit. The legal issues and limited number of suppliers can slow down that decision on the part of the creditors however.
HOW TO OBTAIN A BUSINESS LOAN WITH BAD CREDIT
A new owner can easily wreak havoc on the company’s credit score just by missing payments he owes. With today’s environment in the financial industry, this can greatly handicap that owner from finding loans or obtaining credit. There are ways an owner can improve on his score with a little planning. We are going to take a look at some of the options an owner has to improve their credit rating and some alternative financing options.
A business credit report is just like a personal credit report in that mistakes may be pulling your score down. It is important to thoroughly check the credit report and take the necessary steps with the reporting agencies if there are discrepancies. By providing explanations to a potential lender on problems that show up in your credit report, there is a chance the lender will take them into consideration when making a decision.
Putting collateral up for a business loan is one way of helping to overcome a bad credit report. The collateral will reduce the amount of risk the lender is exposed to and will improve your chances of receiving a loan. It shows good faith on the part of your business that you are willing to put up valuable assets to secure a loan. It indicates to the lender that you are less likely to default on the loan.
Having a co-signer to guarantee the loan is another way to get around a bad credit score and to show the lender that you are going to take pains not to default. Of course the key here is that the co-signer needs to have an excellent credit history. Keep in mind that persuading someone to co-sign may be hard because of the company’s poor credit score.
One way to improve your credit score is by taking on smaller lines of credit and paying them back on time. This takes time to improve your credit history, but it is effective. Depending where your credit score is, it may be easier to obtain smaller lines of credit at this point in time, than something larger. You can work your way up to apply for that later.
Another avenue to travel is to seek out grant money. Certain industries that are very specific may find grants being offered by the government or other organizations. Local governments may also be offering grants if they are trying to build businesses up in a certain area. Grant proposals come in all shapes and sizes, so a consultant should be obtained to prepare one properly.
The absolute final way to get cash if your company is in a critical state of needing funding is to get a cash advance. They can have interest rates of over 20% but can be obtained on a short-term basis and not usually with the restrictions or need of collateral like other loans. The repayment schedule can be flexible but because of the expensive nature of these loans, they should be a last resort.
Financial emergencies happen. All businesses have them and a small business is especially vulnerable. Being prepared to meet such emergencies separates the good companies from the ones that will fold when an emergency occurs. The natural cycle of business can bring this about or the nature of the industry you are in. Advanced planning will help weather such storms and here are some tips on being prepared.
HOW TO READ A DNB REPORT
Many businesses find it beneficial to apply for a Dun and Bradstreet number as they try to obtain financing. This makes the company part of Dun and Bradstreet’s data bank and their report on a company goes a long way in helping lenders determine who they are going to offer money to. A D&B report shows your company’s credit history and the strength of the firm’s financials. It also compares your business with others in the same industry. Their report also provides data on a company’s management, operational structure, and the industry it is in. It gives a good indication of how successful a company will be in paying back a loan or credit line. The D&B reports are used by banks in determining loans and other companies in deciding who to extend credit to. Let’s look at D&B reports in more detail.
This heads the report and gives the important company details of name and address, a full description of what it does, its size and what type of company it is (corporation, partnership, etc.) It also list the founding year, net worth of the company, and its SIC code which shows the industry the company operates in.
This section deals with the company’s financial state. It reviews its history and indicates where the business rates in terms of Financial Stress Class and Credit Score Class. Here is where a lower number is better in the class scale as 1 is excellent and the higher numbers indicate significant negative issues. The Paydex score illustrates how well a company pays its bills based on vendor reports. In this case, a higher score (from 1-100) is indicative of a good payment record. It also shows when a company is likely to pay a debt. The final part of the summary is the Credit Capacity Summary that lists the company’s sales, working capital, net worth, and level of credit.
History and Operations
This section explains the firm’s management structure and operational methods. A list of officers and directors of the company is presented and a short resume of their business activities. Usually, there is also added information on the incorporation of the business and what industry it represents.
Banking and Finance Summary
This will showcase the firm’s financial statements. It should include balance sheets, cash flow, assets, liabilities, financial ratios, etc.
Public Filing Summary
This section will detail any lawsuits, liens, bankruptcy, or other judgments a company may be facing.
A loan underwriter usually requires a D&B report as one of its main information pieces in determining a loan. You need to understand your own D&B report to better strategize how to improve it, or to fix errors that you find in it. Double check that your D&B report is accurate and up-to-date before applying for financing. You can find a great deal more on D&B reports at www.dnb.com .
PRIMERA GROUP, INC.
109 EAST 17TH STREET, SUITE 25, CHEYENNE WY 82001
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