Commercial Credit
Capacity
For companies, the way to evaluate their paying capacity is by analyzing their Financial Statements. Their debt ratio is calculated by dividing their liabilities with their assets. Normally, companies with a good debt ratio stay under 75%. If it’s higher, a company might have difficulties to pay his obligations.
Other factors such as profitability, cash flow, growth and working capital are criteria to evaluate a business credit.
A company could generate important sales, but also needs to be profitable. The profitability of a company is the reason why it exists and why it can stay competitive. If the sales increases but the profit decreases, then the increase of sales is not necessarily a good thing.
Evaluating the cash flow is evaluating the company’s capacity to pay his lenders with “real money”. When we say that a company generates sales, it doesn’t necessarily means that the company receives money to put in the bank. Buyers could pay later or sometimes not at all. If you sell for 1 million in one year but you only get 800,000$ from it, then you only have 800,000$ to pay your loans.
Also, cash flow analyses takes the amortization (equipment devaluation) and add it on the profit, since the Financial Statements translate it like if it was a cost, which is not in practice since the company is not physically paying for the devaluation of equipments, it just devaluate from the original cost. Cash flow is analyzing the “real money” traded during one year, and they need to generate enough cash to pay all there obligations.
One more important aspect is that the short term assets need to be enough to cover the short term liabilities.
A further analysis of the Financial Statements is needed to know how much a company can borrow. A good indicator is the amount of equity a company has.
Try our calculator Commercial Debt Ratio
Goodwill
The goodwill of a company to respect their obligations is evaluated using the commercial credit report, which is primordial in a credit analysis since the Financial Statements don’t always say everything. The Financial Statements inform on the financial situation of the company, but it doesn’t show if the business has some judicial problems or if it has bad relationship with their business partners, which could be a risk for the company. For example, a consistent amount of money battled in court or a credit line suddenly cut by a supplier can seriously harm the financial health of the company, and could even push them into bankruptcy. The commercial credit report completes the analysis by demonstrating the goodwill of the company to respect their obligations; it exposes the company’s behavior with justice, suppliers and financial business partners.
Like an individual, a company has a credit report. Suppliers report to the credit bureau on how the company is paying. The commercial credit report spread out the amounts the company owes to their business partners (trade suppliers and financial suppliers) and are separated in different periods: current account, first past due period (1 to 30 days late), second past due period (31 to 60 days late) and third past due period (61 to 90 days late).
Other aspect such as bounced checks, judgments, collections and if the company protect itself under the bankruptcy laws are shown on the credit bureau. The banking information can also figure on the report, and it indicates the balance on lines of credit, term loans, and the level of satisfaction of the business relationship. All those factors affect the company’s credit score on the commercial credit bureau report.
If we deal with a start up company, this data is pretty much absent because of the lack of references. The evaluation of the company then lies on the personal credit bureau of the shareholder and / or directors, since a company is in many cases managed the same way the owners manage their personal finances. Those individuals will be asked to endorse the company; however, with time, it is possible to build a good commercial credit independent from their shareholders and administrators. A solid commercial credit report can avoid the endorsement of an individual and allow the shareholders and administrators to disconnect from the faith of the company.
Some businesses could have a strong Financial Statement, but could happen to be a difficult business partner. For example, it is not rare to see that companies find a way to finance themselves using the supplier’s credit. This practice is made so that it can pay more, but later, which is shown on the credit bureau. Sometimes, using the supplier’s credit to finance itself is cheaper than using the bank. On the commercial credit bureau, a company can look in trouble because they always pays late, but in fact, it is using this technique in order to pay less interest. Many corporations are using this technique but are not necessarily in danger. The opposite scenario however is less likely to happen, because a company in financial difficulties rarely presents a good credit report.
In conclusion, the commercial credit report is a very useful tool to evaluate a business, but it is not recommended to use it independently from the Financial Statements.
Try our Commercial Credit Score calculator
Here is what affecting a commercial credit score:
- Time reported on the credit bureau
- Current payments
- Number of references
- Payment indicator compare to the year before
- Numbers of derogatory
- Last derogatory event
- The amount of the derogatory
