Small businesses do not have a large asset base or access to unlimited funds. Most often, small businesses establish credit by getting a business credit card, which provides a specific amount of credit that can be used for purchases and operational expenses. Business credit cards are one of the most expensive methods of financing a small business, but with a wide range of cards available, it is possible to select one with the minimum interest rate and additional benefits.
However, banks will not sanction business credit till they see a good track record. The credit worthiness of the business owner comes under close scrutiny, and a thorough credit analysis will be conducted before any credit is made available to the entrepreneur. Credit analysis is conducted by checking out the following:
- Ability to pay-Lenders, individuals or institutions first try to gauge the capacity of the borrower to pay back the sum he takes as a loan. They scrutinize the company’s cash flow, the repayment schedule, the gestation period of the business, the track record of the borrower for previous credit taken, and contingency plan in case of problems.
- Own funds invested in the business-before an organization offers credit for a business, it checks the amount the entrepreneur has invested himself. The larger the percentage, the higher his chances of getting credit because his own funds will ensure that he puts In his best efforts to make the business a success.
- Collateral refers to the guarantees provided by the borrower as security deposits. These may include property or any other assets owned by the borrower. The rationale behind this is to reassure the creditor that if the business fails, their sums will be repaid by liquidating the owner’s assets.
- Purpose of the loan has to be clearly explained along with a commitment that the funds will be used for the sole purpose specified in the agreement. Lenders conduct their own inquiries about the business environment and check the viability of the project.
- The qualifications and experience of the entrepreneur matter a lot to lenders, who have to be convinced that he has the capability to make the project successful. His personality and character determine his credit worthiness.
- Cash flow details are important because the lender has to verify the funds available and the expenditure that needs to be incurred.
- Additional details like profit projections after the first year of operation, the gross and operating profit margins, liquidity and turnover rations, all contribute towards a decision to grant credit to the entrepreneur.
Types of Business Credit Available
The different types of credit that can be used by the entrepreneur for his small business include:
- Business credit cards
- Vendor Lines of credit
- Credit from informal investors
While deciding on the type of credit to take, the borrower has to keep in mind the xost of taking credit and whether he is able to meet all the conditions for repayment. Credit is an expensive proposition but essential for the survival of the business. Eventually, he may opt for credit that does not curtail his power and also comes at an affordable cost.