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.
Goodwill
The goodwill of a company to respect his obligation is evaluated using his credit report. Like an individual, a company has a credit report. Suppliers report on the credit bureau how the company is paying. The commercial credit bureau shows the delays and the portion of what the company pays versus the total amount he owes. Other aspect such as bounced check, judgments, collections and if the company protect itself under the bankruptcy laws. All those factors affect the company’s credit score.
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 then using the bank. On the commercial credit bureau a company can look in trouble because he always pay late, but in fact, it is using this technique in order to pay less interests. Many corporations are using this technique but are not necessarily in danger.
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
