Business Credit Ratings

Similar to your personal credit profile, businesses and corporations also have a credit rating system that potential lenders use to determine their credit worthiness. While there are several smaller companies that offer credit rating services for businesses, Dun and Bradstreet (D&B) is the primary business credit bureau (see http://smallbusiness.dnb.com). For years, D&B has offered a variety of ratings tools that can be used to determine whether to engage in business with a particular company and to determine loan terms.

Unlike personal credit rating, there is no designated standard for determining the credit worthiness of businesses. However, the predominant tool used to determine and establish business credit ratings is D&B's PAYDEX system. Where a personal FICO score is based only on credit history that includes information on how much a person borrows and how well he or she repays their loans, a credit rating for a business takes into consideration company size as determined by assets and number of employees. Where a personal credit rating is based on financial information provided by credit card companies, retail establishments, and financial institutions, a business credit report and rating is determined by information supplied by the business owner and gathered from your vendors, suppliers, and other trade accounts. For this reason, potential lenders may differ from one another in their evaluation of a business' credit history by emphasizing certain qualifications more than others.

The Business Credit Report and Its Terminology

Like most industries, there is a specialized language involved with business credit reports and ratings. The following is a list of some of the most common concepts and terms as well as their definitions:

• Average High Credit / Highest Credit - In order to put a business's credit in perspective, these are based on the total amount of credit owed as compared to the industry as a whole.
• Business in Good Standing - Includes any problems with the business overall.
• Commercial Credit Score - A D&B prediction regarding the chances of an account becoming severely delinquent within one year.
• Comprehensive Report - This is a combination of several D&B business credit reports that paints a more complete picture of the company's credit history. It includes the results of the PAYDEX analysis, a company's credit score and Financial Stress class, as well as any public filings or liens, the business's history and operations (including when it filed for incorporation, annual financial statements, facilities, affiliations, and number of employees).
• Credit Score Class - This is part of the D&B assessment that gauges payment habits to determine how likely it is that a potential account will be delinquent in the next 12 months. The scoring can range from 1 to 5 with 1 being the score assigned for the lowest risk and 5 for the highest.
• Financial Stress Score - This is part of the D&B assessment that analyzes the Financial Stress that a business is experiencing in order to predict how likely it is that a business will fail in the next 12 months.
• PAYDEX - This is D&B's primary assessment that analyzes how likely it is that a company will make it's future payments on time.

D&B Ratings

For many years, Dun & Bradstreet has been the foremost business credit rating service available. Initially, D&B only provided credit analysis and background information on large corporations who did business with other large corporations. In order to prepare a credit profile, D&B relied on information reported to them by these large corporations.

However, today D&B has expanded its services to include credit analysis and reporting for small and mid-sized businesses. These services are offered because D&B understands how important it is for smaller businesses to be able to establish business credit separate from the owners' personal credit in order to be successful.

Interpreting D&B's Ratings
All D&B business credit reports include an analysis of a company's financial strength. This is determined by computing a business's equity or net worth. As shown in the following tables, these ratings can range from HH to small corporations to 5A for large corporations. The ratings are a combination of financial statements provided by the business and credit analysis. There are only three D&B business credit scores: "1" indicates a high score, "2" is a good score, and "3" is a fair score. While a company's financial strength is calculated exclusively by the size of the company, a company's credit analysis is determined by its credit performance. For instance, a company with a net worth of $700,000 will be ranked 1A, but its credit score can be 1, 2, or 3.

The rating classification score has only two categories that are determined by the number of employees a company has. A score of 1R is assigned to companies with 10 employees and up, and a score of 2R is assigned to companies with 1 to 9 employees. Like the analysis of a company's financial strength, a credit score of High, Good, or Fair can be assigned in addition to the rating classification score of 1R or 2R.

The following table summarizes the possible alternative employee range scores that can be assigned:

D&B PAYDEX Score

D&B's PAYDEX system is one of the most accurage predictors of a company's payment performance. By analyzing information about a company's payment experiences, the PAYDEX scale provides a range of scores that reflects a company's overall credit risk. A company that is good at making payments on time is a lower credit risk, so it receives a higher credit score. A perfect PAYDEX score of 80 for a business is equivalent to a FICO score of 750 for an individual. A majority of lenders will consider financing companies with a PAYDEX score of 70 or better.

A company's PAYDEX score is calculated based on reported information to D&B about a company's account histories. When undergoing a PAYDEX credit analysis, a company is asked to provide a minimum of five trade accounts so that D&B can solicit the necessary information to develop a PAYDEX score for that business. The PAYDEX score can reflect a 12-month or 3-month timeframe. With this information, it is possible to evaluate a company's performance within a specific period of time.

When calculating a company's PAYDEX score, D&B creates a weighted average by assigning greater importance to the trade accounts with higher dollar amounts. For example, if five accounts for $50 each report that the company often pays its bills 60 days late, but one account for $50,000 reports that the company pays on time every month, the PAYDEX score for that company will still be relatively high because the payment history with the $50,000 account is weighed more heavily than the $50 accounts with the late payments. The same logic is applied when the larger account is late but the smaller accounts are paid on time; in this case, the company's PAYDEX score will be lower because the late payments on the larger account are weighed more heavily than the smaller accounts that are paid on time.

A high PAYDEX score that reflects a low credit risk is required in order to qualify for the most favorable financing terms from potential lenders. A company that makes its payments either on time or before they are 30 days late is considered to have a low risk of late payment. A company that makes its payments between 30 and 59 days late is considered to have a medium risk of late payment. And a company that makes its payments over 60 days past the agreed date is considered to have a high risk of late payment. The following chart illustrates how a company's PAYDEX score is determined by the timeframe in which it pays its obligations:

Financial Stress Score

A company's Financial Stress score is an evaluation of the likelihood that a company will go out of business and stop paying its creditors in the next twelve months. The scores assigned to Financial Stress can range from 1 to 5.

In the United States, the national average for all businesses in Dun & Bradstreet's database is 1.4%. Typically, businesses in the lowest Financial Stress class have been evaluated to be less likely to go out of business whereas businesses in the highest Financial Stress class have been evaluated to be more likely to go out of business. For example, a company with a Financial Stress score of 4 is predicted to experience moderate to high Financial Stress in the next year. A company that has gone out of business or filed bankruptcy is assigned a Financial Stress score of "0."

Because D&B has such an extensive database of the businesses it has evaluated, it can also provide the average Financial Stress scores within a particular region for businesses in similar industries, with similar years doing business, and similar numbers of employees. This can be very helpful because it can reveal trends of success or failure for similar businesses located in the same region within a particular industry.

Commercial Credit Score

This evaluation is another predictor of the likelihood that a company will make a payment 90 days or more in the next twelve months. A company's Commercial Credit score can range from 101 to 670 with each 40 point decrease or increase halving or doubling the risk of a 90-day delinquency. For instance, a business with a Commercial Credit score of 360 has twice the risk of 90-day delinquency as a company with a Commercial Credit score of 400.

Ranging from 1 to 5, the higher the Commercial Credit score class, the more likely it is that a company will be 90-days delinquent. For example, a company with a score of 5 is considered a very poor risk due to the increased prediction of 90-day delinquency. A company that has gone out of business or filed bankruptcy is assigned a Commercial Credit score of "0."

D&B can also use the Incidence of Delinquent Payment Assignment Table to assign a score to a business. In the United States, the average Delinquent Payment score ranges from 36-45 or 17.3%.

Other Ratings

While Dun & Bradstreet has been the primary company used to evaluate business credit for many years, there are several other companies that have begun to provide similar credit evaluation services to small businesses based on their independent databases:

• Equifax Small Business Enterprise - Equifax, one of the three primary consumer credit rating bureaus, is now providing business credit evaluations for over 22,000,000 small businesses and corporations (www.equifaxsmallbusiness.com). In order to predict the likelihood that a new or existing small business will experience significant delinquency or file bankruptcy in the next twelve months, Equifax has developed the Small Business Credit Risk Score™. This evaluation is based on a combination of reported financial transactions, including banking, leases, trade accounts, public records, as well as the demographics of the business. The Financial Services Credit Risk Score™ assigns a score from 101-992 with the highest score indicating the lowest risk of delinquency and the lowest score indicating the highest risk of delinquency. The Suppliers Credit Risk Score™ assigns a score from 101-816 with the highest score indicating the lowest risk of delinquency and the lowest score indicating the highest risk of delinquency. These scores also include explanations of why a particular business earned that score based on a series of reason codes provided in the report.
• Experian SmartBusinessReports™ - Experian is another one of the three primary consumer credit rating bureaus who has begun to provide business credit evaluations. Unlike D&B and Equifax, Experian's SmartBusinessReports™ do not assign a separate numeric system of evaluation. Instead, it provides a report of the total percentage of on time and late payments made by a company. These payments are broken down into current payments, 1-30 days late, 31-60 days late, 61-90 days late, and 91+ days late. For instance, a report might indicate that a particular company made 75% of its payments on time, 15% of its payments 1-30 days late, 6% of its payments 31-60 days late, 3% of its payments 61-90 days late, and 1% of its payments 91+ days late. Given this information, it would be up to the lender to interpret the risk associated with this type of payment history.
• Credit.net - Credit.net is a division of InfoUSAR that generates credit reports on approximately 15,000,000 businesses (www.credit.net). 6,000,000 of the reports in their database have been completed on small businesses with four employees or less. The credit analysis provided by Credit.net relies on four criteria: years in business, number of employees, public records, and stability within the industry (determined by the success and failure rate of similar businesses within that industry). Once this information is analyzed, an A through C grading system is awarded as an evaluation of the company's credit history. The grading system itself ranges from 70-100 with the better credit risk indicated by the higher numbers. For example, an A+ is awarded to a company with a score of 95 or higher, an A is awarded for 90-94, a B+ is awarded for 85-89, a B is awarded for 80-84, a C+ is awarded for 75-79, and a C is awarded for 70-74. If a company earns a score of less than 70, this is an indication that there is not enough credit history information available on the company to complete the evaluation. Credit.net also provides a determined amount of credit it recommends as well as an overall company credit rating of one to five stars, with one being the lowest and five being the highest scores possible. In its report, Credit.net also includes the number of employees a company has, its annual sales, its location, the number of years a company has been incorporated (if any), number of Yellow Page advertisements, credit card acceptance policies of the company, and any additional corporate involvement. Credit.net also provides a complete list of the company management team, including the company's primary directors and officers, their titles, and phone numbers.
• Accurint™Business - This is a new business that is a combination of forces between The Better Business Bureau (BBB) and LexisNexis, one of the leading providers of business services and information. AccurintRBusiness (www.accurintbusiness.com) is much like Experian in that they provide public and business profile information, including credit history based on payment patterns of small, medium, and large companies. This company provides a payment history only with no unique scoring system to interpret the information.
• ClientChecker - This is a credit reporting bureau that started in 2003 and specifically targets small businesses, freelance professionals, and contractors seeking information to help them determine which other businesses they should do business with. Rather than providing a fixed credit rating, ClientChecker (www.billingtracker.com/index.jsp) compiles information based on feedback from its members.