Scoring a line (of credit)
Wednesday, February 12, 2020
Bread, dough, moolah, dollar, cash – call it what you want – we all have a need and use for it. While the physical is clearly giving way to the digital, money as a medium of exchange, in whatever form, does still make the world go around.
The problem is that access can be restricted or carry a burdensome cost if the borrower is seen as risky. Take a mobile phone contract or an attempt to acquire a car on finance. We’re credit checked and either approved or rejected or, depending on status, have it granted but on expensive terms. Credit checking ties an individual’s record to publicly available information and that which is shared by financial organisations with credit reference agencies.
We know the process as individuals but not everyone appreciates that the same applies to businesses.
Generating the facts
James McGarva, head of business information at Experian, defines a credit score as a “measure of creditworthiness, which is made up from a number of different factors to understand financial position and level of financial risk.” This information, he says, “is combined to create a score, which influences whether companies are seen to be a repayment risk”.
Equifax’s product manager, Andrew Fielder, holds a similar view, but adds that his company looks at data and represents the outcome as not just a score but also “as an amount that a business may be seen as being ‘good for’ on typically a monthly basis.”
A credit rating, he says, “aims to rank relative strengths of businesses against each other on a scale regardless of size, so a business that is scored 20 out of 100 is seen as less able to support credit than a business that scores 80 out of 100.”
Experian uses a similar methodology. It gives a credit score that can range from 0 to 100, with 0 representing a high risk and 100 representing a low risk. 0, for example, would be applied to a failed company, 26-50 to an above average business, while 91-100 is a very low risk firm.
As McGarva outlines, “business information is generally held by a number of credit reference agencies and comes from multiple sources, including creditors, such as banks, credit card companies and building societies, or simply from publicly available records”.
It should be pointed out that the information gathering process is not underhand in any way. And to illustrate this, Fielder explains that the information credit reference agencies obtain comes “from a wide variety of sources that include more well-known entities such as Companies House or the main Gazettes, as well as closed user group information on payment behaviour and newer data sources like Open Banking.”
McGarva says that this information is collated and includes data on existing business credit, such as current accounts, loans and credit card information along with balances and amounts outstanding. On top of that is data on payment performance “which”, he says, “can offer real insight into a business’ financial standing – and any potential problems they might be experiencing”; County Court Judgments (CCJs) and bankruptcies – this type of information is, according to McGarva, “particularly significant to potential or existing suppliers and lenders. It can indicate severe financial difficulties and may well act as a red flag to those considering working with them”; and Companies House records such as details on the directors, previous company names and annual returns.
Of course, it’s entirely possible that a business can hunt down some of the information itself – the publicly available part that is. But the benefit of using a credit reference agency follows, as Fielder notes, “from the fact that agencies will look at data in a number of ways, using aggregated data sources and applying analytical methodologies to build the score.” He carries on, saying, that “agencies use a database that has been built up over time to understand how businesses that were created historically have performed over an extended period.” He adds that scores may also incorporate personal data on company directors.
As noted earlier, whenever an application for credit is made, information on a credit report will be used along with other sources of information to determine whether a lender will agree to the request and on what terms.
And this is why firms, according to Fielder, should make every effort to have a good report as it influences their ability to make purchases. He says: “Business credit ratings are not as ubiquitous as personal credit ratings, however they are more prevalent when dealing with larger purchases or lending decisions, such as for a loan or a business vehicle.”
And credit ratings have effectively been mandated by the authorities. Fielder explains that “in line with Financial Conduct Authority principles, [lenders] score to promote responsible lending decisions and ensure that businesses only take on debt they can afford to repay”. He says that lenders may use credit scores as part of a wider data evaluation process that may differ by lender and product.”
It follows that a well-managed credit report will be seen by lenders as a positive. But as McGarva details, “businesses with little to no financial history – known as ‘thin file’ businesses – may struggle to be accepted or get the best rates. In these circumstances, a business owner’s or director’s personal credit scores can be considered to help with the decision.”
In the world of credit, information is clearly everything; if it is suspected that the information held is inaccurate or plainly wrong, steps should be taken to correct it. McGarva says that the only option here is to dispute the business credit report by contacting the relevant credit reference agencies. Not only can they correct data that can be shown to be inaccurate, but they also have services to review whole reports. Experian is a good example; it offers a Credit Review Service.
Credit information for suppliers
The wonder of information is that it invariably has more than one purpose. Just as a credit report allows a lender a window into the world of a (potential) borrower, so the process can be reversed by a business looking to check on its suppliers and its customers.
McGarva makes the case here as being one of commercial survival as “any business can protect their revenue flow by running credit score reports on their customers to ensure they can pay for their services”.
But checking potential clients for their ability to pay isn’t the only advantage of credit checking.
Credit information can aid the fight against fraud in that credit checking a business can confirm that contacts and clients are who they say they are – and that their business is performing the way they say it is. For McGarva “this kind of due diligence can save a lot of hassle and lost revenue down the line.”
Lastly, and firms themselves will have been on the receiving end of this, credit information allows a firm to set credit limits and rates for clients precisely because it’s possible to understand a prospect’s previous payment behaviour and their credit history. While the process allows lower risk borrowers to get more favourable terms, it helps them reduce their own risk, should a client default.
Credit reference agencies offer a variety of services to support a firm dealing with a large volume of clients. Here Fielder details that products to note “include services such as ad-hoc credit reports or the ability to use the data for account opening and account management”.
Of course, each agency will do something similar and more. Equifax, for example, offers products to age verify, bank account verify, document verify, and more. Firms should hunt around.
The cost of protection
The costs associated with credit information aren’t as horrific as might be expected. McGarva reckons that Experian’s Business Express – which costs from £25 per month – “has one of the most predictive scoring models in the industry and lets a business easily determine the creditworthiness of their business partners”. He asserts that it can help a business predict business credit risks and failures within the next 12 months.
Alternatively, where a business wants to check and improve its own business credit score, Experian has My Business Profile at a cost of £24.99 per month. “This,” says McGarva, “enables a business owner or director to gain full visibility of their business credit profile, enabling them to understand what’s affecting their company credit score”.
Granted it’s a cost, but for Fielder, credit ratings tell subscribers which companies are growing, and which are shrinking and that’s got to be a benefit to those working on credit terms.
Like it or not, credit information exists and is here to stay. Whether it’s to borrow or to seek terms with a supplier, having an impeccable credit report is going to put a business head and shoulders above its rivals. And with margins being thin in a competitive world, as Tesco says, every little bit helps.
How to improve a credit rating
- View your business credit report to understand the positive and negative factors in your history and plan the best path for progress
- Make a note of suppliers’ payment terms and plan payments so they are on time. Poor payment performance can indicate a business struggling to service its debts
- File annual returns and ensure financial accounts are filed on time. Making more information on your business available helps suppliers, utility providers and lenders to understand it and make appropriate decisions
- Avoid County Court Judgments. Should one occur, settle it promptly
- Keep an eye on your personal finances. Directors’ personal credit scores can be taken into account for new businesses when little information is available
- Appoint a director with a strong history of running companies and a good credit score to help boost your company’s standing
- Check and monitor the credit status of the companies you work with, so you can anticipate any supply chain problems before it affects the business