If you own a small business, you’ve probably thought about how to get funding to expand it. Understanding the big picture of business credit will be extremely beneficial to you. Understanding how small business funding works, how business credit scores are calculated, how they differ from personal credit scores, and the importance of establishing a good credit history will help you succeed as your business grows.
First things first, what is a credit score? The credit score is a statistical method for determining the likelihood of an individual repaying that they owe. Several credit bureaus will evaluate your credit history and provide lenders with a score. Every credit bureau has a unique evaluation system, and the calculation is based on a wide range of variables.
Credit scores are an essential aspect of any business, especially for micro, small, and medium enterprises (MSMEs). A credit score is a numeric representation of a borrower’s creditworthiness and is used by lenders to evaluate the borrower’s ability to repay loans. It plays a crucial role in determining whether a borrower is eligible for a loan and what the interest rate and terms of the loan will be.
This article will explain why the credit score is important for every business, how to check credit score, and why it is critical to establish good credit before applying for funding.
Financial inclusion isn’t a level playing field for everyone, and obtaining credit can be a hurdle for many reasons. This could be due to a lack of documented borrowing history, limited access to formal financial services, or inadequate financial literacy. India boasts over 633.9 lakhs of MSME businesses, but the financial landscape is uneven. While high-end firms rake in revenues exceeding ₹250 crores, the lower end comprises single-person operations like grocers, vehicle operators, and village artisans. Industry narratives suggest a concerning credit gap, with only an estimated 6-10 million MSMEs having formal access to credit, and this figure might be even lower.
Something as fundamental as formalising an MSME business’s bank statements could be a significant driver for increased credit availability. Since banks might not always be forthcoming with loans, these businesses may be forced to turn to informal sources to meet their financial needs. However, the biggest challenge they face isn’t just loan rejection but also the agonisingly slow loan approval process. While banks have a valid reason to be cautious about fraud and credit risk, incorporating field investigations along with financial education initiatives can play a critical role in mitigating these concerns.
Offering a longer loan term, access to a broader spectrum of credit options, and diverse product choices can also be beneficial. Unsecured lending is generally preferred by MSMEs as most of these small businesses lack assets to pledge as collateral. Additionally, establishing a robust MSME credit score system would provide a more holistic view of a business’s financial health, potentially improving its loan eligibility.
A credit score is a three-digit number that represents a borrower’s creditworthiness. It is one of the most crucial pieces of information that lenders, banks, and other financial institutions use to determine whether or not to lend money or extend credit. The credit score is calculated based on a borrower’s credit history, which includes their payment history, the amount of debt they have, the types of credit they use, and how long they’ve had credit. A high credit score indicates that the borrower is likely to repay their debts on time, while a low credit score indicates that the borrower may be at higher risk of defaulting on their debts.
One of the main reasons why credit scores are important is that they are used by lenders to determine a borrower’s creditworthiness. A higher credit score usually means that a borrower is less risky to lend money to, and as a result, they may be offered better loan terms, such as lower interest rates and higher credit limits. Conversely, a lower credit score could result in a borrower being denied credit or receiving unfavorable loan terms, such as higher interest rates and lower credit limits.
Another reason why credit scores are important is that they can impact a borrower’s ability to secure certain types of loans, such as mortgages and car loans. Many lenders require a minimum credit score for these types of loans, and if a borrower’s credit score falls below the required threshold, they may be unable to obtain the loan. Even if a borrower is approved for a loan with a lower credit score, they may end up paying significantly more in interest and fees over the life of the loan.
Additionally, credit scores can impact a borrower’s ability to rent a place, or obtain insurance. Landlords, employers, and insurance companies often use credit scores to determine a person’s level of responsibility and financial stability. A low credit score could result in a landlord rejecting an application for an apartment or an employer passing over a job candidate for a position that requires financial responsibility.
Here are some points outlining the value of credit scores for MSMEs and how they can modify their business operations.
One of the significant advantages of having a good credit score is the ability to access funding. MSMEs often need funds to expand their business or invest in new projects, and lenders are hesitant to lend to businesses with a poor credit score. Having a good credit score gives the lender confidence that the borrower has a history of repaying debts on time, making them more likely to approve the loan application.
In addition to increasing the chances of loan approval, a good credit score can also lead to lower interest rates on loans. A high credit score indicates that the borrower is less risky to lend to, resulting in lenders offering lower interest rates on loans. This can significantly reduce the overall cost of borrowing for MSMEs, allowing them to save money and invest in other areas of their business.
A good credit score also gives MSMEs negotiating power when it comes to securing loans. With a high credit score, borrowers can negotiate better terms and lower interest rates with lenders. This gives MSMEs more control over their borrowing, allowing them to choose lenders that offer the best terms and conditions.
MSMEs with a good credit score can also benefit from increased credit limits. Lenders are more likely to increase credit limits for borrowers with a history of paying debts on time and managing their finances responsibly. This can give MSMEs access to more funding, enabling them to grow their business and take advantage of new opportunities.
A good credit score can also enhance the reputation of MSMEs in the business world. It demonstrates that the business is financially responsible and has a history of repaying debts on time. This can increase the trust and confidence that other businesses have in the MSME, potentially leading to new business partnerships and opportunities.
Payment history: A business’s payment history is one of the most significant factors that can impact its credit score. Late or missed payments can significantly reduce a business’s credit score.
Credit utilization: Credit utilization refers to the amount of credit a business uses compared to its available credit. High credit utilization can negatively impact a business’s credit score.
Credit age: The age of a business’s credit accounts also plays a role in determining its credit score. Older accounts are viewed more favorably than newer ones.
Type of credit: The type of credit a business uses, such as installment loans or revolving credit, can also impact its credit score. Revolving credit, such as credit cards, can be viewed as riskier than installment loans.
Public records: Public records, such as bankruptcies, liens, and judgments, can negatively impact a business’s credit score.
Credit inquiries: Every time a business applies for credit, it generates an inquiry on its credit report. Too many inquiries in a short period can negatively impact a business’s credit score.
Financial performance: A business’s financial performance, including its revenue, profitability, and cash flow, can also impact its credit score. Strong financial performance can indicate that a business is less risky to lend to.
A business’s credit score is impacted by a variety of factors, some of which are controllable while others are not. It is important for businesses to monitor their credit reports regularly and take steps to improve their credit scores where possible.
Maintaining a high credit score is crucial for businesses as it can affect their ability to obtain credit and the terms on which it is offered. Here are some tips to ensure that a business’s credit score is always high:
Make payments on time: Paying bills on time is the most important factor in maintaining a high credit score. Late or missed payments can significantly damage a business’s credit score.
Keep credit utilization low: Keeping credit utilization low is another critical factor in maintaining a high credit score. It is recommended to keep credit utilization below 30% of the available credit limit.
Monitor credit reports regularly: Businesses should monitor their credit reports regularly to ensure that they are accurate and up-to-date. Any errors or inaccuracies should be disputed with the credit bureau.
Use credit responsibly: Businesses should use credit responsibly and only borrow what they need and can afford to repay. Applying for credit only when necessary can help avoid unnecessary inquiries on the credit report.
Maintain a diverse credit mix: Having a diverse credit mix, including both revolving and installment credit, can positively impact a business’s credit score.
Avoid opening too many new accounts: Opening too many new accounts within a short period can negatively impact a business’s credit score. It is important to apply for credit selectively and only when necessary.
Improve financial performance: Strong financial performance, including profitability, cash flow, and revenue growth, can positively impact a business’s credit score.
Overall, maintaining a high credit score requires discipline, responsible credit management, and regular monitoring of credit reports. By following these tips, businesses can ensure that their credit scores remain strong and enable them to obtain credit on favorable terms.
Credit scores play a critical role in the success of MSMEs. These businesses often rely on credit to fund their operations, invest in growth, and overcome financial challenges. Without access to credit, many MSMEs struggle to survive, let alone thrive. Therefore, maintaining a good credit score is essential for MSMEs to obtain credit and secure favorable terms.
The factors that impact credit scores may vary depending on the credit bureau. However, businesses must be aware of the key factors that contribute to a high credit score. For example, timely payments are crucial in building a strong credit history, and missed or late payments can negatively impact credit scores. Additionally, high credit utilization, a short credit history, and a poor mix of credit accounts can all harm a business’s credit score.
On the other hand, businesses that maintain a positive credit history and healthy financial performance can benefit from a high credit score. A good credit score can result in better interest rates, higher credit limits, and improved repayment terms. In turn, this can allow businesses to invest in growth, manage cash flow, and weather economic downturns more effectively.
While it takes time and effort to maintain a high credit score, the rewards can be significant for MSMEs. By following best practices for credit management, including regularly monitoring credit reports and taking corrective actions, businesses can improve their creditworthiness and access the funding they need to achieve their goals.
In summary, MSMEs must prioritize credit management to maintain a high credit score. Doing so can lead to significant benefits, including improved access to credit, better financing terms, and increased financial stability. By understanding the factors that impact credit scores and following best practices for credit management, MSMEs can set themselves up for success and achieve long-term growth and prosperity.
To overcome their financing needs, MSME owners can reach out to Kinara Capital, a leading fintech which aims to empower small business owners by providing them collateral-free business loans. Kinara has disbursed over 90,000 loans worth INR 6700+ crore till date. To avail an MSME Loan, the applicant can check their loan eligibility in the myKinara app which is available to download from the Google PlayStore and gives the user an opportunity to choose their preferred vernacular language from the 7 options available. Also, we have a dedicated customer support team available between Monday – Friday (9.30 AM – 6.00 PM) at our toll free number 1800-103-2683 for any questions or assistance. This ensures that entrepreneurs can get the help they need throughout the loan process.
1. How is a credit score calculated for MSMEs?
The CIBIL MSME Rank (CMR) is a credit score for MSMEs. It ranges from 1 to 10, with 1 being the best. It considers factors like payment behaviour, credit history, liquidity, credit utilisation ratio, firmographics, business size and industry type, and outstanding debt. A good CMR helps businesses secure better loan rates and terms.
2. How does a good credit score benefit an MSME?
A robust MSME credit score can unlock financial resources to fuel a business’s expansion and growth ambitions. A strong score signifies the borrower as a lower risk and a reliable borrower, leading to several advantages for MSMEs, such as expedited loan approvals, favourable interest rates, enhanced negotiation leverage, and increased borrowing capacity.
3. Can an MSME get a loan with a low credit score?
Enterprises with a low CIBIL score are not necessarily denied a loan, but it becomes difficult to secure one at a lower interest rate. If your business has a poor credit score, NBFCs are an option for obtaining a business loan. These financial institutions lack banking licenses but can offer loans at relatively higher interest rates. Generally, NBFCs are more lenient with the credit scores of borrowers or enterprises.
4. What is the minimum credit score required for an MSME to qualify for a business loan?
The minimum credit score needed for an MSME to qualify for a business loan is typically around 700, though some lenders might be more lenient. However, a higher score can boost the likelihood of loan approval and may also result in better terms and interest rates.
5. Can an MSME with a low credit score still qualify for a government-backed loan program?
Absolutely, an MSME with a poor credit score can still seek assistance from a government-supported loan program. Although a credit score of 750 or higher is typically regarded as favourable for MSME loans, certain lenders may show flexibility regarding the minimum credit score criteria for small businesses.
6. What are some common misconceptions about credit scores for MSMEs?
Common misconceptions about credit scores for MSMEs include thinking that a low score means automatic loan rejection (it’s still possible to get a loan with a low score), believing that a perfect score guarantees loan approval (other factors matter too), and assuming that all lenders have the same credit score requirements (requirements can vary among lenders).
