We recently sold the assets of an insolvent business. While all the trappings of the business were appealing, the owners had lost the trust of their creditors because of poor payment history and broken promises. When the employees got word that the business was in trouble they found other employment. The loss of revenue forced the business to close. The happy chimes of the registers will only sound for someone else.
Good credit is critical to business growth and longevity. Just this week a franchisor denied a buyer the right to purchase a franchise despite a cash offer. The reason? Poor credit. Good credit cannot be purchased with cash, but must be earned with consistency over time.
The first rule of developing good credit is "delay gratification." Put off buying what you want until you can afford to pay for it.
"Make do" is the next rule of good credit and necessitated by delaying gratification. You are better off painting your old Honda than buying a new Beemer. Having cash to pay your bills is more impressive than conspicuous consumption.
"Promptly pay," making your payments on time is sound credit policy. Every time your account is past due, it raises a flag that something is wrong and over time reduces your credit rating.
"Limit borrowing limits," as having multiple credit cards or lines of credit is a warning to creditors that you can easily become overextended. Limiting your supply of easy credit assuages concerns.
The preceding rules apply to all business owners but especially to start-up entrepreneurs, because they address personal habits as opposed to business policy. Two more rules that apply to start-ups and transition to all business owners are "negotiate" and "document." Always ask for better terms and make sure the deals you cut are written and signed.
The most important rule of establishing good credit for a business is "show a profit." In the early stages of a business, the owner personally guarantees all loans and leases. The owner's personal assets are at risk. If the owner ever wants to defer the risk to the business, then the business must show a profit on the tax returns over several years.
Income is only part of creating an independent credit rating. The business must also "increase equity" by acquiring capital assets such as land and equipment. A lender or creditor wants collateral or something they can attach should the business default.
"Be a smart creditor" -- earning good credit can be the result of learning to be a good lender. Before you extend credit to others, ensure that they are credit worthy. You can't pay your bills if you don't collect from your clients.
"Measure income against cost" -- before you borrow money or enter a lease, you should project how much money the transaction will produce and justify it with return on investment.
Credit extends beyond your personal financial statement and your business. It touches all aspects of the global economy. We were all affected by the recent credit meltdown. If you think I sound alarmist, "Ask not for whom the bell tolls. It tolls for thee."
-- Russ Allred, MBA, is a business consultant and author with Sunbelt Business Brokers & Advisors. These are his opinions, not necessarily those of The Californian.