Small business owners often blur the lines between personal credit history and business credit history – and that is understandable considering it is hard for newly-established businesses to get financing without at least a year's record of credit history. It is a chicken and egg situation: you cannot get a business loan without credit history and good credit scores; but you cannot attain good credit history without first showing you have paid back loans.
If you are an SME owner, company director, or shareholder, banks can decide whether to approve your business loan based on your personal credit history. Investopedia defines your credit history as a measure of your ability to repay debts and demonstrated responsibility in repaying them. Your credit report details: (1) the number and types of your credit accounts e.g. loans, utility bills, or credit cards, (2) how long each account has been open, (3) amounts owed, (4) amount of available credit used, (5) timeliness in paying your bills, and (6) the number of recent credit inquiries (these are often triggered by bankers when you try to apply for a credit card, house, car or personal loan).
Your credit report also contains information regarding whether you have any bankruptcies, liens, collections, or judgments. Thus, having a good credit score has an outsize impact on whether and how much money banks decide to loan you or extend credit cards to you or your business.
In Malaysia, the central bank Bank Negara Malaysia's (BNM) Central Credit Reference Information System (CCRIS) Report lists a borrower's financing and repayment history over the past 12 months, as reported by participating financial institutions. Whenever you apply for a loan or credit card, the bank or lender you are applying with can access your CCRIS report. You can access your credit reports online via eCCRIS for free.
Separately, business owners can keep track of their SME's credit rating via CTOS SME Score. This business credit score combines data from various sources, including CCRIS and the Companies Commission of Malaysia (SSM), to calculate your SME score using five key factors: payment history, amounts owed, financial performance, credit mix, and pursuit of new credit.
Credit history and credit scores are important as they speak to your Character as a borrower. Character is one of the 5Cs of Credit, a general rule of thumb used to determine how creditworthy borrowers are: character, capacity, capital, collateral, conditions.
|The 5Cs of Credit||Definition|
|Character||Otherwise known as credit history, i.e. a record of how responsible you have been in paying your bills, loans, and other credit accounts on time.|
|Capacity||Your debt-to-income ratio, i.e. are you able to repay a new loan given your existing debts and income inflows?|
|Capital||How serious you are as a borrower, i.e. are you willing to put down a large down payment on your business/home or vehicle loans?|
|Collateral||An assurance to the bank or lender that if you default on the loan, the bank can repossess an asset you put up as collateral, i.e. if you default on your home/car loan repayments, the bank has the right to repossess and auction off the home/car.|
|Conditions||Additional factors that may affect your ability to service the loan (some of which may be out of your control), e.g. macroeconomic conditions, sectoral performance, how long your business has been operating, and cash flows.|
Source: (Investopedia, 2023)
You already know that Character, the first C of Credit, is heavily dependent on your credit history and score. To improve or get started on a business credit history, formalise your business by registering it with SSM. You should also open a business current account (BCA) so as to separate your business credit history from your personal credit history. Next, apply for a business credit card to set up a track record of good creditworthiness. On the personal side, directors, partners, and sole proprietors must continue to pay bills, credit cards, and existing loans on time as these will affect the business as well.
To improve your business' Capacity, apply for loans or credit cards only when you need to, as it affects your debt-to-income ratio. More applications means more enquiries will be made to your CCRIS, which may negatively affect your rating as it shows bankers you are 'shopping around'.
Meanwhile, for Capital, put larger down payments for your equipment/business premise financing loans even if a bank has high margin financing. If a loan product offers up to 95% margin financing, it means you only need to contribute 5% of capital. However, if you voluntarily pay 10-15% upfront instead, this tells your bank that you are serious about repaying, and you may just enjoy lower interest rates or smaller monthly repayment amounts as a result.
Just like Capital, improving your business' Collateral is a pretty straightforward thing to keep in mind: simply apply for collateralised loans to buy or lease new office premises or company machinery/vehicles, as there is less risk to the bank if you default on payments.
Last but not least, you should remember there are Conditions that you cannot fully control. These include macroeconomic conditions the COVID-19 pandemic shutting down international borders and keeping people home in their lockdowns. Social distancing precautions heavily hit the retail sector, especially in non-essential or luxury segments.
However, not all businesses that were affected by the pandemic failed to receive funding: those with strong credit histories and a good business credit score with regards to the other 4Cs were able to receive funding to tide them over, either by putting up assets as collateral, showing a good history of paying their debts, and having a low debt-to-income ratio by cutting costs. These borrowers could mitigate the impacts of lockdowns by having a strong cash flow projection or historical balance sheet, while making moves to embrace online marketing and e-commerce to show their ability to pivot quickly.
For first-time entrepreneurs, once you've registered your company, you need to set up a business bank account that is separate from your personal account. This makes it easier for banks to infer the 5Cs of your business creditworthiness. With Alliance Digital SME, entrepreneurs can open a BCA in three steps, without even needing to leave their business premises. Alliance Digital SME also offers a variety of loans, both secured (equipment/business premise financing) and unsecured (Express/Cash Flow). These latter two collateral-free loans can be applied for entirely online, giving you access to quick, vital credit to grow your business and take advantage of growth opportunities as they come by.
For a limited time only, the Alliance Digital SME Express Financing solution is offering fixed interest rates as low as 4.88% per annum, with collateral-free financing of up to RM300,000. Find out more and kickstart your journey to a strong business credit score today.