March is Credit Education Month, a time dedicated to empowering individuals and businesses with the knowledge they need to make informed financial decisions. For business owners, understanding credit is a crucial step toward securing funding, managing cash flow, and promoting long-term success.
We sat down with Drake Bank’s Chief Credit Officer, Daniel Batten, to get expert insights on building credit, avoiding common pitfalls, and positioning your building a better future for your business.
Why is business credit important, and how does it differ from personal credit?
Batten: Business credit allows a business to utilize capital in the form of debt to grow its operations and increase the company’s value. In most cases, a business owner’s largest asset in the net worth calculation is the business itself.
The distinction from personal credit is who is responsible for the repayment of the debt. While a personal guaranty on business debt makes the owner responsible for ultimate payment, the cash flow of the business is the primary source of repayment.
What are the key steps for a new business to establish and build credit?
Batten: A business will need to identify its borrowing needs and craft a plan that shows how the debt will be deployed and repaid. This is a great conversation to have with a community banker.
What factors do banks and lenders consider when evaluating business financing needs?
Batten: Banks tend to use the 5 Cs of Credit: Character, Capacity, Capital, Collateral, and Conditions. Character is the applicant’s history, capacity is the business’s ability to pay back the loan, capital is the business’s financial resources, collateral is any asset that can be used to secure the loan, and conditions are the economic and industry-specific factors that might affect the borrower.
How can business owners improve their creditworthiness for future financing needs?
Batten: A business owner can make their company more creditworthy by keeping equity in the company versus taking all the profits out. They can also limit expenses if they are able to, allowing the company’s gross profit to increase. It is also helpful to run the company’s finances in a timely and efficient manner. A bank will notice both positive and negative trends.
What are common mistakes business owners make that hurt their creditworthiness?
Batten: One of the most common errors that business owners make is not correctly balancing the desire to mitigate potential tax liability for the business or the owners with the need to show income. A bank needs to see that the business has the income to service the debt.
What’s one key piece of credit advice you’d give to business owners?
Batten: Do not take all the equity out of your company, focus on your expenses while continuing to try to increase your sales, and do not over-leverage your company. The correct level of debt will assist a company in growing. Too much debt will hinder growth and may cause failure. A company that is stable with equity is more appealing to an institution than one that has no equity and is highly leveraged.
By understanding how business credit works and adopting sound financial habits, business owners can pave the way toward sustainable growth and long-term financial success.
For any questions or to learn more, contact your Drake Bank banker.
