How to boost your credit score to raise finance
Lifting the lid on how businesses' credit ratings are calculated, so you can take action to improve yours
Martin Williams, of credit scoring agency Graydon, lifts the lid on how businesses’ credit ratings are calculated and offers tips on how to improve yours
“You will not survive without credit in this world,” says Martin Williams, managing director of credit scoring agency, Graydon UK. It’s a notion many businesses will have become painfully aware of over the past 18 months. However, as we come to terms with the consequences of an era of cheap and available credit, where sound businesses will invariably be punished for others’ irresponsible lending and borrowing, proving your creditworthiness will be crucial in the search for capital to grow.
But it’s not just being refused a bank loan that you need to worry about. It’s not practical, or even possible, to pay suppliers immediately, especially if you’re at the mercy of a larger customer dragging its heels. Trading relationships depend upon credit facilities being granted. With economic pressures forcing everyone to reassess risk, if you’ve got a poor credit score, suppliers may ask you to pay upfront, draw up stricter terms or even demand personal guarantees.
In short, boosting your credit score can help you to secure far better deals that will give you the breathing space you need to run your business. But exactly how these scores are derived is shrouded in mystery.
Paying your suppliers on time will certainly help, but there are many other factors that are taken into account, Williams reveals. While he would not divulge all of them, he agreed to offer some insight into how creditworthiness is assessed to help you improve your chances of accessing credit and getting the most out of your trading relationships.
No news is bad news
It’s a well-known fact that people with no borrowing history can be just as scuppered when applying for credit as those who have run into trouble previously – and it’s the same in business.
“Credit scoring is empirically derived – it needs to examine the past to predict the future,” explains Williams. “So, if someone has got no credit history at all, their future performance can’t be predicted.”
One of the problems businesses face is that, often, there isn’t much for credit agencies to go on. The information that incorporated companies are legally bound to file at Companies House, such as financials and details of directors and shareholders, will all have an impact. However, the requirements have been relaxed over the years. “Governments have tried to cut red tape and bureaucracy, and it has saved small businesses money, but they now only have to file very abbreviated, even unaudited, accounts by law,” says Williams. He adds that this makes it far more difficult to assess a firm’s creditworthiness.
For sole traders and partnerships, it’s even harder. “There isn’t a government registry where private businesses can, or have to, file anything,” says Williams. “There is a dearth of information, which is a shame, because in the credit-checking world the absence of data can be just as damaging as bad information.”
Credit scoring agencies can compensate for this shortage by finding out from your suppliers what kind of payer you are. They will look at their customers’ books to see when their sales invoices are being raised and paid. “We actually ask our customers to donate their sales ledgers to us, so we’re picking up trade experiences, or payment records, on small businesses anyway,” he says. “If they’re a poor payer, they will get found out. If they’re a good payer, they’ll also get found out and will benefit from that.”
You can, of course, include the names of suppliers who can vouch for your payment record on credit application forms, which Williams recommends, but he admits that agencies will expect to get positive feedback from supplied referees.
Something that will reflect badly on you in the eyes of the credit agencies is what Williams calls “high gearing”, where external debt, such as money owed to banks, is much higher in proportion to shareholders’ equity – the combination of what shareholders have paid into the business and any retained profits in the business. “We much prefer to see businesses self-generate money, or for the shareholders to put cash in, rather than go to a bank,” he says.
That’s not to say that bank loans are a no-no, and making regular and punctual repayments on a loan is actually a good way to create a sound credit history. But the ratio should not be tilted in favour of debt. Companies that are mostly externally financed make those who rate credit nervous. “If I had a million pounds of loans outstanding, but also a million pounds of my own shareholders’ money in the business, that’s 50:50, which is not too bad,” says Williams. “It’s the relationship between the two that’s important.”
Having a positive working capital will also affect your credit score. Credit agencies will take into account the difference between your current assets and liabilities, or what’s coming in and going out of your business on a daily basis.
Your current assets, including stock, cash in the bank and work in progress, should be higher than your liabilities, such as anything owed to trade creditors and any bank overdraft. “That means you’ve probably got a good cashflow position – you’re getting more money in every day than you’re having to pay out,” says Williams, adding that turnover growth and profitability are also good indications of creditworthiness.
The age of your business will also come into play. “It’s a fact that older businesses are more trustworthy than new companies,” says Williams, although he is not unsympathetic to the difficulties this can pose for young, yet viable companies.
“Growing businesses that are new probably have the worst problems,” he concedes. “You have to trade for a whole year, then you’ve got 10 months to file your first year accounts at Companies House. So in the first 20 months of your existence, traditionally no one has seen any financials from you. The credit agencies and the banks will only go up to a certain minimal level of credit rating.”
Graydon is currently working alongside a company called Validis to help businesses in this predicament supply up-to-date, monthly management accounts, which can then be assessed. “Credit agencies can take that information and turn it to that business’ advantage by doing a credit rating on them,” explains Williams. He argues that if there are positive markers in your accounts, the last thing you want to do is hide them away.
By managing your sales ledger effectively and staying on top of credit control, you can ensure your customers are paying you on time, which in turn will help you to pay your suppliers promptly. Williams recommends looking at the payment terms or record of your suppliers and customers. “Do they unilaterally impose terms?” he asks. “Are they the type of customers that will just pay slowly? You have got to look up and down the line so that you avoid getting squeezed.”
While there has been a lot of talk about individuals taking control of their credit scores in recent years, small firms appear surprisingly oblivious to the value of a good credit rating. Williams recommends all business owners take steps to establish how their creditworthiness is perceived in the marketplace.
“Small businesses must stop seeing credit scores as some kind of hidden weapon used by credit granters to restrict their business growth,” he insists. “This is simply not the case. Instead, they should look at credit scores as a very useful tool that they can learn to utilise to help their businesses grow.”