Business owners often overlook credit scores, but this number is a key determining factor when lenders assess your loan or line of credit applications. A low score will lead to higher interest rates and potential denial of loans.
Here are three dangerous mistakes business owners make regarding their credit.
Mistake #1: Not Checking Your Credit Score
Your credit score isn’t just important for getting a good interest rate on your mortgage or qualifying for a rewards credit card. It can also impact your business’s ability to get financing. If you have a low personal credit score, lenders may view you as a higher-risk borrower and be less likely to approve a loan for your business. Depending on the credit scoring model, fair credit generally falls in the range of 580 to 669; good credit is 670 to 739; very good credit is 740 to 799; and excellent credit is 800 and up.
Before applying for business financing, look at your credit report and score to see where you stand. If your score could improve, pay down debt and improve your payment history. Here’s what you can do to improve your credit score:
- Pay your bills on time.
- Apply for new credit only as needed.
- Pay existing debt; don’t move it around.
- Don’t close unused credit cards as a short-term strategy to raise your scores.
- Dispute errors on your report.
- Communicate with lenders about late or missing payments.
Mistake #2: Mixing Business and Personal Finances
Keeping your business and personal finances separate is important for legal and practical reasons. Many business owners choose to split their personal and business finances to take advantage of tax deductions for their businesses, including writing off expenses.
The risk of commingling funds could also put your assets at risk if your business is sued. But even if that doesn’t happen, mixing business and personal expenses makes it much more difficult to track your spending and keep tabs on your cash flow.
It is also tempting to use business credit cards for personal expenses or to tap into a business line of credit to pay for things like vacations or a new car. However, this can put your business in a precarious financial position if you cannot make the payments. This will also affect your business operations, such as being unable to get inventory because you have maxed out your line of credit.
To avoid confusion (and temptation), open up a separate bank account for your business and only use it for business expenses. Keep your business and personal finances separate by opening a business bank account and getting a business credit card. Regarding expenses, ensure you only use business funds for business purposes and vice versa. You can also start paying yourself a salary; this way, you will have income from your business to cover personal expenses.
It also helps to track when you use personal items for your business. For example, if you use your car for business errands, track the mileage for tax purposes. Write off legal expenses if you want to save money during tax season. Your tax advisor will be able to help you determine what is and isn’t deductible and how best to keep records.
Mistake #3: Applying for Too Much Credit
Applying for too much credit quickly can result in a decreased credit score. When you try to get new lines of credit, the lender will make a hard inquiry on your history, which temporarily lowers the score.
New accounts are integral to your credit score, comprising 10% of it. If you’re constantly applying for new credit cards, it’ll likely result in a dip in your score. The reason is that each new card will generate a hard inquiry on your report.
If you plan on applying for a business loan or credit card, try to space out your applications so they are not all concentrated quickly. Plan when you need financing to avoid harming your credit score and space out your applications accordingly. Even if you only have two credit cards, if you don’t plan on using one, it might be best to cut it up so you’re not tempted to use it and rack up debt.
Have a Financial Goal in Place
If you plan your finances accordingly, you will help yourself stay disciplined with your spending and avoid racking up debt. Having a plan will also help you avoid making impulsive decisions that could jeopardize your business. As a business owner, you can avoid these credit mistakes if you have a financial goal in place.
If you plan to apply for a business loan, know how much you need and why. Say you’re starting a food cart business and need $10,000 for a cart, supplies, and three months of living expenses. You need to be able to explain this to lenders and show how you plan on making the payments.
The same goes for using personal funds for your business. It would be best if you had a plan for how to repay any money you borrow from yourself or others. This could be through revenue generated from your business or by taking on additional part-time work. If you plan on using a business credit card, track your expenses and aim to keep your balance below 30% of your credit limit.
The Bottom Line
Your business credit score is important, as it can affect your ability to get financing, rent office space, or hire employees. Following this guide can improve your score and avoid making common credit mistakes.