Bottom Line: Assets Or Liabilities?
Understanding credit reports and making them work
for you
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Regular review of your company and personal financial statements
is necessary for fiscal growth and well-being. So, the obvious question:
do you a have clear understanding of how assets relate to liabilities,
as well as how net worth and equity appears on paper? So it’s vital to have a working knowledge of the “ins and outs” of a credit profile. Credit rep-orting at the business and personal levels is closely reviewed by lenders more at the present time than in the past. Business at all levels is less personal than ever perhaps the best word to describe it is “dehumanized” leading to a sometimes harsh reality that indeed says the answers are all in the numbers. |
Fortunately, you don’t have to be an accountant (heaven forbid!). You
just need to be able to think like one. With that in mind, let’s have
a look at the basics.
A SCORING SYSTEM
In the U.S. there are three credit reporting agencies; Equifax, Experian,
and Trans Union. Each reports personal payment histories as presented
by the creditors you work with. Note: in many cases business debts are
also reported on personal credit reports.
In recent years, these agencies have moved toward a scoring system. This
system, known as FICO, is designed to provide a more accurate accounting
of payment habits and financial stability of the individual. With regard
to business credit reporting, Dunn & Bradstreet (D & B) is most commonly
used.
How does all of this relate to you, particularly if you own a business?
Let’s just say that business and personal credit ranks very high on your
“asset” list.
But if you’re not aware of what’s being said on a report, you could be
sitting on a large pile of “liabilities” you may know little to nothing
about. And that’s where problems, some of them long-term in nature, can
rear up and prevent you from access to financing that can be vital to
growth.
Keep in mind that legal records remain on your credit report for time
periods ranging from seven to 10 years. Even if settled immediately upon
discovering a problem, these don’t immediately disappear and thus can
haunt you for years to come!
Credit reporting is an imperfect science and unless there is awareness
of what’s being said, the result can be erroneous credit reporting. Also,
a good understanding of what is reported can help you prepare strategies
and responses to any potential problem spots.
Therefore, I strongly encourage annual reviews of all three personal credit
reports, as well as your Dunn & Bradstreet report. (Several online resources
allow you to order a consolidation of all three reports for a minimal
fee.) And really, forget the cost it’s nothing compared to the damage
that bad debt can instill on your future.
TYPES OF DEBT
First, a credit report lists current employer, place of residence and
Social Security Number. Minor stuff, indeed, but when reviewing a report,
be sure to double check the accuracy of this information. Mistakes are
not at all uncommon, and can be hard to rectify. (I’m sure you’re all
familiar with the phrase “bureaucratic nightmare.”)
Next, three types of debt are typically presented:
Installment debt: Based on predetermined terms, usually shown as loans, mortgages, leases, and notes. This debt is usually billed monthly at the same rate and has a beginning and end date.
Revolving debt: Without a predetermined end date, payments can vary depending on the exposure amount and the minimum accepted payment. Example include credit cards (Visa, MasterCard, Diners Club), charge cards (American Express) and department store credit cards.
Legal Recording debt: Any legal recording such as liens, suits or judgments.
Going back to the credit scoring system, FICO, each agency has its own
way of naming its reporting system as well as its own scoring system.
The better the credit history, the better the score.
Equifax calls its system “Beacon” with a scoring scale of 350 to 850.
Expreian has dubbed its system “Experian/Fair, Isaac Risk Model” with
a scale of 340 to 820. And Trans Union has come up with the name “Emperica”
and a scale of 300 to 850.
Despite the difference in name and scale, all three report in a similar
fashion. When creditors review a report, they look at a few things: timeliness
of payments, how much is owed in relation to what’s available, age of
accounts, new credit (debt), and types of credit taken on.
NOT BETTER LATE
Making payments on time is crucial. It’s illogical to think that by paying
creditors slow, you’ll attract new ones. Keep in mind that payment history
accounts for 35 percent of the total credit (FICO) score. An occasional
late payment is typically acceptable, but if a pattern is present, forget
it.
Revolving debt is a positive, but if more than 50 percent of the credit
available is outstanding, it raises a red flag. Rather than paying off
installment loans early, bring down the revolving debt.
What appears to be a low interest rate on a credit card means nothing
if it’s never paid off! Carrying installment debt is fine, but creditors
like to see balances paid down. This shows a willingness to manage and
repay debts. How much is owed in relation to how much is available
amounts to about 30 percent of a FICO score.
Lenders like to see history, so maintain relationships with older credit
and department store cards. Showing long-term fiscal responsibility can
be a huge feather in your cap. Length of credit amounts to about 15 percent
of the FICO score.
Taking on a large amount of new credit (debt) is certainly a Catch-22.
Using the money of others is, in many cases, the only way to grow a business.
However, keeping a close eye on how credit is being taken is highly advisable.
Did you know that inquiries remain on your credit report for two years?
So be careful, new credit accounts can amount to 10 percent of the FICO
score.
Finally, a good mix of accounts will help to improve a FICO score. Having
a nice blend of timely paid credit cards, retail accounts, installment
loans, and mortgages all contribute to a healthy credit score. This rounds
out the final 10 percent of the score.
See, that wasn’t so hard. The more difficult part, by far, lays in the
practice of responsible credit, a responsibility that can’t be taken lightly
because it can have serious consequences now and in the far-distant future.
It’s Who You Know...
Check your personal credit report with each reporting agency. To request a copy from each, here’s contact info:
EQUIFAX
800-685-1111
www.equifax.com
EXPERIAN
888-397-3742
www.experian.com
TRANS UNION
800-888-4213
www.transunion.com
NOTE: If you discover an error in your credit, these agencies are required to investigate and respond within 30 days. And when taking business credit into consideration, there’s one primary reporting agency, Dun & Bradstreet, at www.dnb.com
Doug Kocsis is head of DK Capital, Inc., a financial services company well versed in working with the needs of small businesses. He can be reached at doug@dkcapitalinc.com
November 2003 Live Sound International