Being a small business owner, having the knowledge and correct understanding of essential business credit terms is very important.
You have probably considered tons of ways to get funding to grow your business. Even with the savings if you can commence your business, there will be a time of day when you will be in a need of funding.
This is when you need to have the valuation of your business and the correct knowledge of business credit that will help you as it enhances your company’s and your ability to get funded. Having the financial model handy will help you predict the future financial position of your business which in return will provide credibility to your business and help others form or gain trust in the way your firm manages money.
You don’t have to necessarily be an expert to understand business credit, but just gaining the knowledge of some basic terms and understanding its purpose will help you a lot with your business and its doings.
To help you out, I’d further mention ten business credit terms that are a must for you to know:
1. Cash flow
Cash flow is a statement that shows the inflow and outflow of cash and cash equivalents of a business. It is an important statement as one can easily measure by looking at your cash flow if your company manages its cash position well or not.
A cash flow statement shows how well you can pay off your debts and fund your operating expenses. It can help investors to understand the workings of your company, its financial strength, and how and where the cash is being utilized.
Further, it also helps creditors to understand if the company has cash available for it to pay debts and make operating expenses.
Other uses of a cash flow are as follows:
- Determines cash flow per share and the percentage of cash flow yield.
- Determines the price of the stock.
- Helps with a Funding gap, dividend payments, and capital expenditures.
2. Income Statement (Profit and Loss Statement)
A Profit and Loss Statement, formerly known as the net income statement is a summary of all the revenue, expenses, and profits or loss incurred over a while. This statement provides information on the company’s ability to generate sales, workout expenses, and at last its ability to generate profits.
The Profit and Loss statement is issued annually or quarterly along with the Balance sheet and the Cash flow statement. These are the 3 most important financial statements that every company ought to issue.
As we already know, a P&L statement is made monthly, quarterly and yearly. It includes the following categories:
- Cost of Goods Sold
- General and Administrative Expenses.
- Research and Development Expenses.
- Net Income.
3. Accounts Receivables
It is the amount that a company is yet to receive from its customers who have purchased goods and services on credit. The credit period ranges from a few days to months but to be paid within a year. Therefore, falling under Current assets on the balance sheet.
Example of Accounts receivables: An electric company bills its customers after they have already utilized the electricity. Therefore, recording account receivables for the unpaid bills.
4. Line of Credit
A line of credit is an arrangement with a bank, credit union, or lender that establishes a maximum credit the customer can borrow. It is said to be a flexible loan as the borrower has the access to funds anytime until and unless it reaches the line of credit.
Types of credit lines are:
- Home Equity
A line of credit is pretty similar to a credit card as you have access to funds as and when you wish to, and the interest is charged at the time the money is borrowed.
Here, I have mentioned a few types of credit lines for you to better understand:
- Business credit lines: This is a line of credit with a bank or any lender which is used to cover the operating expenses.
- Home equity line of credit: This line of credit uses home equity to pay for home development, renovations and can be used for other expenses as well.
- Credit cards: This is a personal account with a set limit for the consumer that renews monthly. Interest or charges apply if unable to pay the remaining amount till the end of the set period.
Your line of credit depends upon a few factors such as the collateral you offer, your loan reason, and the most important your personal and business credit card rating.
5. Business Credit Score
As a personal credit score represents one’s credit history, a business credit score represents if the company is good enough to receive credit or not.
A business credit score is calculated by the credit scoring firms based on the company’s past repayment history and the basis of its meeting the credit obligations in comparison to similar companies. In short, one of the most important considerations a bank or lender would consider while giving out a loan.
Remember, for a small business owner, its credit score is also taken into consideration most of the time. A few ways to maintain a good credit score:
- Good Payment History.
- Credit Balances should not be too high.
- Do not cancel old credit accounts.
- Manage your debts.
- Stay away from red flags.
6. Business Credit Report
A Business Credit report is created by the credit bureaus which contains a detailed report of a company’s detailed credit history. Whenever needed, it clearly and quickly shows the company’s payment behavior and if it will be able to meet all the obligations needed for a successful contract in the future.
These reports are of utmost importance and should be tracked regularly as the lenders, potential partners, and suppliers will rely on these reports and make a decision accordingly.
A Good Business Credit Report consists of the following:
- Company Profile.
- Credit Summary.
- Public records of any legal cases.
- Risk and Failure Score.
- Overview of payments.
- Additional Company Information (If needed).
7. Gross Margin (Gross Profit)
The Gross Profit of a business is the revenue obtained after deducting the Cost of Goods sold from The Total Revenue. Gross profit is included in the Profit and Loss Statement.
Gross profit is essential as it is used to check the sales of a company in regards to its production costs and the gross profitability of its operations.
The formula to get gross margin is:
Gross margin = Gross Profit / Total Revenue x 100
Gross profit is the gross margin that a company would have before deducting the administrative, selling, and general expenses. Also, it does not include the one-time paid charges such as depreciation and interest paid.
8. Net Terms
Net terms are conditions that define payment terms. These terms allow businesses to offer credit to their vendor or suppliers in exchange for these terms to repay them. These businesses provide 30, 60, or 90 days for the repayment. It is also known as net-30, net-60, net-90 terms.
Businesses to recover soon also provide discounts if they agree to repay 10 or 5 days before their invoice date. In most cases, there is a delay in the repayment and therefore a late interest fee is charged against the invoice.
Everything good comes with its cons, so do these net terms.
Below is a list of its pros as well as cons.
- Greater Competitive advantage
- Enhanced Sales
- New Clients
- Customer loyalty gained
- Chances of potential debts.
- Irregular cash flow
- Lesser margins if discounts are provided.
Collateral is an asset or property offered by a firm or an individual as security for a loan acting as a protection for the lender. If there’s a default in the repayment of the loan, the lender has the right to seize this asset and sell or keep it at its disposal.
For example, if a person has to take a loan from a bank, he may use his property or any asset like his car or bike as collateral.
10. Personal Guarantee
A personal guarantee is an individual promise to repay the loan issued to a business to which they are a partner. They act as a guarantor and allow the lender to acquire its assets in case of default. These fall under the category of unsecured debts.
Further, the biggest benefit it provides is access to funds for a small or medium-sized business that lacks credit history or is not able to access funds.
For example, Stock traders often acquire guarantees from an older guarantor in case the individual in the deal is a minor.
We all know having access to business credit is a lifeline for every small or growing business. It gives you access to buy inventory, cope with the daily expenses and use the cash whenever needed.
You should take all necessary steps to build your business credit and make your financial position strong and therefore increase your chances to get more financial opportunities.
Remember, the better creditworthy your business, the better are your chances of getting funded.
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Claire Mark is an investment and strategic planning consultant at Alcor, a global investment bank. She’s best known for her insightful blogs on business growth, startups, small businesses, and investments. Claire also has a good network in the Finance industry, especially the investors’ community. Apart from her work, she loves to bake and go out for gadget-free nature walks.