For new business owners looking to set up their business or a medium, small and micro enterprise (MSME) wanting to explore new business opportunities for scaling up, it is necessary to know that strong creditworthiness is imperative to avail credit from formal lenders to achieve your business goals.
Here’s what you need to know about the common mistakes an MSME should avoid in order to stay creditworthy to avail business loans.
What is a Business Credit Score?
Your business’ credit score is calculated based on your credit behaviour over the previous 36 months. In case you have not availed any loan during this tenure, the credit bureau will not be able to assign a credit score due to dearth of data.
The proprietor’s credit behaviour and personal credit score, in the case of both a partnership and proprietorship, also counts when the business is assessed for lending.
Therefore, it is best that the business avails some loan, or the proprietor has credit card dues, and they are repaid on time, such that you can have a good score when you have to opt for a loan.
Whether it is to invest in new equipment, or to expand the business, or to pay off supplier credit, every business owner may have to take a loan at critical points in their business lifecycle. However, if your credit score is low, many banks and lending institutions will not approve your business loan application.
Your credit score would also impact the rate of interest and the structure of the loan that you will get from non-banking financial companies (NBFCs). Hence, it is imperative to understand what mistakes could impact your business’ credit score.
Mistakes To Avoid For A Good Business Credit Score
High intensity of loan build-up
Credit score gets impacted if a business owner takes too many loans in a short period of time. This is perceived by lenders as a sign that the customer is credit hungry. Availing too many unsecured loans may raise red flags with lenders, so it is necessary for business owners to make use of a mix of unsecured and secured loans.
Guaranteeing a third-party loan
If a business owner stands guarantor to a loan availed by a third party and that third party defaults, the business owner’s/ guarantor’s credit score could be impacted even though he is not directly paying that loan.
By acting as a guarantor, you agree to be responsible for the repayment of the loan. In the first place, avoid giving such guarantees. If you must, you should be very cautious at the time of giving the guarantee, as someone else’s behaviour could impact your score. And if you have done so, nudge the person to adhere to the repayment timelines.
Not monitoring and updating the credit report
Another common mistake which people make is ignoring disputed amounts in the credit report. For instance, if no action is taken on incorrect dues, the amount would start to accumulate and draw interest. This would then balloon into a large sum and reflect in your outstanding credit. Do not ignore any disputed amount and follow up till it is fully resolved.
A business owner must also monitor his business’ credit profiles on a regular basis and not just once, viz. monthly, or quarterly. Going through the credit report is a must to understand the reasons for the low score.
If there are any irregularities that may be reflected in the credit score, it is even more important to raise the dispute on time as improving a low score takes time. Some examples of such irregularities are that a loan may be mistakenly attributed to the business that the business has not taken, or a loan that has been paid off completely may not be shown as “closed” by the lender.
Applying for loans from multiple lenders
When applying for a business loan, applying to too many lenders at once does not actually work in your favour. It is important that you apply only where you’re fairly confident that your application will get approved. It is also wise to restrict your loan application to only a couple of lenders when enquiring within a short period.
If you are working with a direct selling agent or a referral agent, while handing over your loan application to them, clearly communicate and ensure that they send your loan application only to a certain number of lenders. Be cognizant of too many loan enquiries; every enquiry on your credit report is noted and too many of them will bring down the credit score.
Restructuring of a loan
When businesses opt for loan restructuring, the same is shown as ‘restructured’ in their credit report as well. Banks and NBFCs are cautious of lending to such MSMEs. Any relaxation or waiver of terms of loans raises red flags with lenders that the MSME is incapable of repayment.
Bottom Line
Good credit report based on a business’ timely repayment and responsible financial behaviour indicates to lenders that the business is a creditworthy borrower. Lenders provide pre-approved loans to such customers, and a higher quantum of loan at that, without asking any questions.The loan process becomes smoother. Is there any downside, one may ask? Not at all. So, follow these tips and strengthen your business credit score before you avail your next loan.
