What Is a Credit Score and How Does It Affect You and Your Business?

If you are seeking any type of credit — whether a credit card, home loan, personal loan or business loan — your credit score will come into play. It’s a lending term that’s thrown around a lot and you might be asking, ‘What is a credit score?’

It’s simply a number that is calculated based on the information in your credit file at a point in time. It helps credit providers determine how creditworthy you are and how able you will be to pay back any new debt they give you.

How are credit scores used?

Personal and business credit scores are used by banks, credit unions and other credit providers to determine if and how much money they will lend to you. It can also affect what interest rate you are offered.

If you are a sole-trader or in a partnership, your personal credit score will most likely be used in determining your eligibility for a business loan and how much you can borrow. Sometimes lenders will use both your personal and business credit scores when making lending decisions.

Here we’ll cover both personal and business credit scores and how they affect your ability to get finance for your business.

What determines your personal credit score?

Credit reporting agencies collect your personal and financial information and combine it to create your credit report. The information on your credit report includes:

Your personal details – including your age and address
The organisations that have given you credit – banks, credit unions, utility companies
The amount of money you have borrowed (e.g. personal loans, mortgages & property loans, car loans etc.)
How many enquiries and credit applications you have made
Loans or credit cards that are overdue or have not been paid
Any personal insolvency or debt agreements related to bankruptcy

All of this information is analysed to determine your credit score or credit rating. Depending on the credit reporting agency, your number will range from zero to 1,000 or zero to 1,200. The number you receive on the scale is rated on a five-category scale. These ratings are Excellent, Very Good, Good, Average and Below Average, depending on how likely you will be to experience an adverse event such as a default, bankruptcy or court judgement.

Excellent – it’s highly unlikely that an adverse event will harm your credit score over the next 12 months.
Very good – it’s unlikely that you will have an adverse event affecting your credit score in the next 12 months.
Good – it’s less likely that you will experience an adverse event over the next year.
Average – it’s likely that you will have an adverse event over the next 12 months.
Below average – it’s more likely you will experience an adverse event over the next year.

Your position on this scale enables lenders to determine the risk level of lending to you.

Keeping track of your personal credit score

Keep in mind that your credit score will change as your financial situation changes. For this reason, it’s a good idea to check your credit report and credit score. It’s also important to ensure that all the information is correct on your credit report and that no fraud has occurred. For example, criminals could steal your identity and get credit in your name, so it’s good to check your report from time to time to ensure all information is correct.

You can get your credit report for free but there’s usually a catch. When you agree to get a free credit report, you might be agreeing to share your details with third parties for marketing to you. Read the fine print before you agree to provide your personal information for a free credit report. You can unsubscribe or opt out if you don’t want to share these details with third-party vendors.

How can you improve your credit score?

Your credit score is a dynamic number that will change over time based on the information in your credit report. Factors that influence your credit score include:

Making late payments on existing loans or credit cards
Applying for a new credit card or loan
Changing the credit limit on an existing loan or credit card
A creditor providing new information to the credit reporting agency
Closing a credit card or loan account

You can begin improving your credit rating by examining your current financial situation and determining ways to improve it. As you improve your financial situation, your credit score will improve. Ways you can improve your credit score include:

Paying all your loans and bills on time, including credit cards, utilities, mortgage repayments and any other loans
Limiting the number of credit applications you make
Consolidating personal loans and credit cards
Lowering the limits on your credit cards
Paying credit cards off in full each month

You will also want to check your credit report to determine if anything is wrong on it. If it shows outstanding debt that you have paid, or any other incorrect information, contact the credit reporting agency and let them know. If that doesn’t work, the next step is to speak with the credit provider and explain what is incorrect on your credit report.

Start by getting your credit score

If you are not sure about your credit score, you can get it online for free from several credit reporting agencies.

What is a business credit score?

In addition to personal credit scores, credit rating agencies also provide business credit reports and credit scores. Business credit scores are based on business credit and finance activity – including business payment history, credit enquiries, judgements and defaults. A business credit score will also consider your industry, the size of your business and your trading history.

As with personal credit scores, business credit scores fall into the categories of Below Average, Average, Good, Very Good and Excellent. Business credit scores are ranked on a scale from 1 to 1200. Research conducted in 2018 found that the average business credit score was 769, which falls in the Very Good category. It also showed that 80% of businesses have a score of Good or above, and one-third of businesses have an Excellent credit score.

Understanding the importance of your business credit score

For banks and other lenders, your business credit score is an indicator of your ability to repay the loan. Whtehr you’re looking for farm machinery loans, office equipment finance or finance for trucking, lenders will look at your credit score when deciding whether to give you a loan, the amount of the loan and the interest rate.

Some of your suppliers could also look at your business credit score to determine how much credit they extend to you and payment terms, such as 30 or 60 days. If your credit score is too low, you may be required to prepay or pay cash on delivery. Unfavourable payment terms will harm your cash flow because the gap between when you pay for products and receive payment from sales will be extended.

If you bid for large products with government departments and large corporations, they are likely to check your business credit report when considering whether to award a contract to your company. They will choose businesses that are above a predetermined minimum credit score. So if your business credit score is too low, you will be out of the running in competitive bidding scenarios.

How to establish and improve your business credit score

A good place to start building your business credit score is by not using your personal credit to make business purchases. There will come a time when you will need to get more credit for your business. If you only have a personal credit history, it could make it more challenging. You can start small in building your business credit score by getting a business credit card. As you use it to make purchases, ensure that you make your monthly payments on time.

Paying all your bills on time will also help you build your business credit score. Missed or late payments can be a large contributor to getting a low score.

Work with your vendors and suppliers to build and maintain good relationships. Communicating effectively with these organisations, and building a good reputation, will make it easier to get favourable trading terms with your suppliers. Some companies report to credit agencies, so ask them to report your positive payment history to improve your credit score.

One important point to consider is ATO debt. As of 2017, the Australian Taxation Office began reporting unpaid tax debts to credit reporting agencies. The ATO has the discretion to report Australian businesses that owe the ATO more than $10,000 and have a debt that is more than 90 days overdue. If you have tax debt meeting this criteria, it could end up on your credit report. The ATO offers payment plans for outstanding tax debt. If you enter a payment plan with the ATO and continue to make regular payments, the ATO won’t report your debt to credit reporting agencies.

Finally, you cannot improve what you don’t know, so find out your business credit score and get a copy of your business credit report. Go over it to make sure it’s accurate. As with your personal credit score, if something doesn’t seem correct, contact the credit reporting agency to rectify it. If that doesn’t work, speak with the credit provider that has reported incorrect information about your business.

Since your credit report and business credit score are dynamic and subject to change, you will want to monitor them regularly. So check your business credit report a few times each year to make sure that the information is correct and up to date.

If you have any additional questions about credit reports, ask your Broker!