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The recent turmoil with the general economy and the reduction in availablecapital has changed the way that businesses approach and provide credit.Small business owners should understand these changes in order toincrease the probability of obtaining business credit.

stablishing and managing business credit is the lifeblood of any small business. Always a challenging task, obtaining funding within the current economic environment and reduction in available capital is even more difficult for small businesses. Many business owners who did not establish small business credit prior to the onset of the recession and could not obtain needed capital were forced to liquidate personal assets and resort to using personal credit in order to continue operating. The first step business owners should take to avoid the need to utilize personal assets in financing their business is to manage their small business credit well in advance of financing needs so that they are in a favorable position when a need for financing arises.

During periods of economic strength, business credit is relatively inexpensive and available for businesses seeking to expand their operations. Since the economic downturn and the contraction of the capital markets, access to capital has contracted, forcing many businesses to find other forms of financing. In the process, the definition of credit has expanded to include methods of financing beyond traditional bank loans. Faced with more stringent requirements from banks, many businesses have turned to alternative sources, including trade credit from other business partners which effectively provides businesses with more operating capital in the form of longer payment terms.

In order to maintain and expand operations, small businesses require ongoing access to debt capital or other forms of credit that can help bridge periods of diminishing revenues and other economic pressures. Building business relationships and establishing business credit are best done during periods of economic health, so that businesses remain solvent and have access to needed capital during tough economic times.

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Securing Capital in a Crunch:What Small Businesses Can Do

Underwrite Your Small Business

he recent recession and reduction in lending capacity has changed the ways firms are financed. In order to increase their probability of obtaining credit, business owners should underwrite their businesses in the same manner prospective lenders or creditors would underwrite them. Understanding how credit is underwritten gives owners insight into how their business operations can be modified to increase the probability of receiving a business loan or favorable payment terms from merchants.

Performing cash flow forecasts and subsequent scenario analyses provides small business owners with an appreciation for what is crucial to the continued operation of their business. Forecasting cash flow will also help business owners identify any previously unforeseen financial risks and determine the amount of working capital necessary to mitigate these risks. Additionally, a business owner should fully understand the revenue drivers of their business and how these revenue drivers affect cash flow and the overall credit worthiness of their business.

Cash flow and profitability are only some of the items that potentialcreditors will review to assess a company’s ability to cover itsshort-term obligations. The following represent a non-inclusive listof factors that may be reviewed to determine credit worthiness:

• Activity reports and payment histories from businesses that provide services on credit, including suppliers, utility companies, etc.• Credit activity reports and deposit data from lenders and financial institutions.• Commercial scores or other credit metrics created specifically to address credit quality. Some examples include: – Dun & Bradstreet’s PAYDEX® score, which reflects a business’s payment habits. – Fair Isaac’s Small Business Scoring Service (SBSSSM).

Business owners should organize and gather all necessary paperwork in advance so that potential creditors have all needed information to make a financing decision. One important step that simplifies the underwriting process is separating personal assets from business resources. At the startup of any business, lenders will often consider an owner’s personal credit history in order to provide business credit. However, by setting up business checking and savings accounts, loans and credit lines, as well as credit or charge cards exclusively for the business, owners can start reducing the impact that any personal credit problems may have on business credit.

In addition to giving creditors insight into business operations, owners also need to demonstrate any predetermined plans to mitigate downside risks. Evidence that management has the judgment to forecast cash flow, identify potential financial issues, and develop plans to resolve potential cash flow problems will provide considerable assurance to prospective spon-sors. Acknowledgment will also be given to those businesses with the forethought to establish their small business credit and take charge of their market reputation.

Creditors are more likely to extend credit if the capital will be used to support a well-researched and crafted fiscal strategy. Simply lacking sufficient capital to continue operating is not an appropriate reason to apply for credit. Most lenders will be understandably wary of any firm that foresees financial trouble. However, creditors are likely to provide the funds or payment flexibility necessary to preserve a firm’s financial health and to help it avoid potential issues identified by a proactive analysis. Any capital provided must provide maximum return at the lowest possible risk. The risk involved in funding a financially stable company that is expecting a period of diminishing sales is much different than one trying to recover from diminished sales.

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Acquiring Small Business Loans

ince capital is tight and business loans are difficult to secure, companies should be especially vigilant in securing and building their credit worthiness. Businesses can do this by building a credit profile, creating a cash flow analysis,

documenting vendor and customer testimonials, payment histories, as well as receiving a solid PAYDEX® and other credit scores.

To determine the probability of attaining a business loan and what part of the firm’s operations may need to be modified to make a company more credit worthy, business owners should ask themselves the same questions they are likely to face from potential lenders. In addition to a business credit profile, most lenders will also review the “5 Cs” to determine whether a business is credit worthy:

• CAPACITY: Does a business have adequate working capital to cover its short-term obligations, including the debt service from any existing or potential loans? Having analyzed cash flow in advance will demonstrate that a business has determined its ability to cover operating expenses.

• CHARACTER: Will a business pay its obligations? This is where business credibility and small business credit has a large impact on loan approval.

• COLLATERAL: What assets or guarantees can a business provide to collateralize the debt? The greater the cash reserves and cash flow, the less important additional collateral should be in making the loan.

• CAPITAL: What is the loan-to-value (LTV) ratio of the loan? How much additional equity or financial risk will a business owner have in the company once it is financed?

• CONDITIONS: What are the loan’s proceeds to be used for? Once again, any analysis that can demonstrate the additional value that will be created from the loan proceeds, the greater the probability of approval.

In response to a dynamic economy, the banking model continues to change. The ability of banks to understand and under-write its clients’ businesses is getting progressively more complex. Increased regulation, more centralized decision-making and tighter credit restrictions have decreased the flexibility that was once afforded to local bankers. Additionally, the impact of the internet as a marketplace and the fact that most customers do not reside in the local market make it increasingly hard for lenders to determine credit quality. As a result, businesses are advised to address both the statistical measures of their credit-worthiness as well as the non-statistical measures such as their overall credibility.

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In terms of statistical measures, banks tend to base lending decisions on scores such as PAYDEX® and the D&B Financial Stress Score. By documenting good payment history through companies such as Dun & Bradstreet Credibility Corp., business owners can increase their scores.

In addition, adding good payment history into a business’s credit profile can enhance the softer and more subjective aspects of a business’s overall credibility.

A risk that lenders face by relying exclusively on measurable statistics is that they can mislead underwriters as to a borrower’s dependability. Financial state-ments alone do not show entirety of a company’s financial position and may not provide an accurate indication of future financial performance. What is far more important for lenders to understand about small businesses is whether they are credit worthy and credible. This is only accomplished by examining the business holistically and understanding what customers and dealers believe, the quality of management, the firm’s position in the market, and other empirical methods to determine credit quality. Collecting this type of practical information and including it in a well-constructed credit profile will provide potential lenders with a more accurate view of a business than they are set up to gain on their own.

Due to the reduction in available capital and more conservative underwriting guidelines, lenders need to find additional reasons to make business loans. In ad-dition to good business credit and a solid business relationship, providing lenders with a proactive analysis that demonstrates the purpose and value proposition for a loan can make the difference between it being accepted and rejected.

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Obtaining Vendor Support for Small Business Credit

he recent economic downturn and resulting tightening of the credit markets have also changed the way credit is supplied and acquired. In addition to lending, different approaches to financing have emerged. One method for obtaining badly needed funds is through trade credit. Foregoing the need for banks, businesses (especially those in partnership arrangements) rely on each other for trade credit. In periods of financial stress, businesses will undoubtedlyrequire more than just high PAYDEX® scores and other similar gauges to provide credit; therefore, small business owners should build their firm’s business credibility in order to obtain the necessary support from vendors and creditors.

Payment terms that allow buyers a grace period before cash payment is due is a necessary form of credit that has been available well before the establishment of commercial banks. In the current economic environment, the availability and lower cost of capital in relation to other forms of financing can make trade credit a more effective financing alternative than short-term bank loans and credit lines.

For example, a vendor could give a business customer extended payment terms of 60 days instead of 30 days. By allowing the business to operate and earn enough money to pay for inventory at the end of the 60 days, the vendor continues a business relationship that might have otherwise disappeared.

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Trade credit can be provided in several different forms, including extended payment terms, quantity discounts, equipment loans, and consignment sales. Each of these represents speculation by the sponsoring company on a projected investment return from ongoing trade with an established business. Since the expected return has to increase with a corresponding increase in risk, anything that can lower the perception of risk will be rewarded with better provisions and greater flexibil-ity. The following are steps that should be taken when applying for trade credit:

MAKE A FORMAL APPLICATION FOR CREDIT: Every business that extends trade credit should require that their formal ap-plication, including the applicant business’s formal name, ownership, and information on banking relationships and other credit providers, is completed. Signing the application gives the reviewing firm the right to contact the applicant’s bank and trade references for transaction histories. The application should allow applicants to include a business credit profile and any other information that would aid in making the credit decision.

In the current economy, not having the necessary information or business credibility can result in the rejection of a credit application, a request for a personal guarantee or, ultimately, having to pay COD (Cash on Delivery) for inventory that would have been otherwise billed on credit.

MANAGE BANK AND TRADE REFERENCES: If the sponsoring company asks for a business’s bank and trade references, it means that they are planning to contact them. The failure of a company to adequately discuss its credit needs and goals with its references, or waiting until the last minute to inform their references that they may be contacted may increase the risk of rejection. Managing a small business credit profile enables business owners to orchestrate what vendors will see when they decide how much credit to extend to the business. A company’s business credit should be well-managed so as to maximize a company’s ability to secure credit.

CHECK CREDIT BUREAUS AND OTHER CREDIT METRICS: Companies such as Dun & Bradstreet Credibility Corp. enable businesses to monitor and manage their various business credit scores. By working with companies such as Dun & Bradstreet Credibility Corp., companies can identify potentially inaccurate information and document good payment history. Any errors in the bureaus’ reports must be fixed, and any seemingly negative information should be addressed and explained in a business’s credit profile or included in the credit application.

SET EXCEPTIONS WITH CREDITORS: When seeking trade credit fromvendors, a company should realistically set the vendor’s expectationsby analyzing its cash flow and determining the impact of credit on the business. Be specific about the need and use of capital so that vendors can assess their investment return. Once again, any information thatcan help reduce the perception of risk will also help a business ownerobtain the necessary funding.

Setting expectations does not end after credit is extended. Actual performance should be tracked and communicated with vendors. The ability of a company to achieve its goals will help maintain and even enhance credit terms, and will promote the business’s credibility so it can obtain other sources of financing.

Making the decision to provide what amounts to large short-term interest-free or low-interest loans is not made lightly. In fact, since suppliers should initially understand a business better than potential lenders, a strong business relationship can itself serve as a type of reference to aid the decision making process.

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Other Sources of Cash for Small Businesses

anaging .sevitanretla gnicnanfi rehto fo egatnavda ekat ot deriuqer osla si sdeen ssenisub gnitsacerof dna wofl hsac Another method of obtaining funds is factoring. Although it has been available for some time, recent economic pressures and the increased demand for cash has made factoring a more valuable way to increase asset turnover.

Factoring is a financial transaction that allows a business to sell its accumulated credit invoices (i.e. accounts receivable) to a third party (“factor”) at a predetermined discount in exchange for cash. For example, a company might only receive 95% of the face value of its receivables (5% discount) in order to get the funds immediately. The transfer of ownership also transfers all the rights and risks of the receivables to the factor. The factor, which is usually better resourced and skilled to take on the collection function, makes its profit from collecting the invoices at face value.

Small businesses that enter into these transactions can command a greater return from an early investment of cash in the business (including the transaction cost or fees paid to the factor in the form of the invoice discounts) than it could if it waited to collect its receivables at face value. Businesses may also sell their receivables if a lack of working capital is impeding its ability to continue operations.

Although factoring may be used regularly by companies that have continued difficulty managing and collecting their receiv-able balances, it is a valuable short-term alternative for companies that have exhausted their credit options and still have unfunded operating capacity. By analyzing their sales potential and cash flow needs, these companies have determined the amount of sales that are being lost due to inadequate working capital reserves. To maximize return and minimize the amount of discounted receivables, small business owners must be able to quantify future operating performance and determine the resources required to fund it. Being able to manage cash flow at this level, and to implement successful operating strategies, builds business credibility and provides reassurance to creditors when they are asked to provide more substantial forms of credit.

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As the economy recovers, changes in the credit markets are forcing businesses to rely more on each other and less on financial institutions for the capital and payment flexibility needed to operate. Businesses are willing to finance customers because doing so helps to expand the entire market. However, these changes also require small business owners to build the necessary business relationships far in advance of their need for capital.

Conclusion

s the economy enters a period of volatility, the overall trend that small businesses are witnessing is changing the definition of credit. As a result of the recent global economic crisis and illiquidity in the fixed-income markets, businesses are being forced to obtain and provide financial support in new ways. Lenders and other creditors have to find new ways to build business relationships, and owners have to do a better job of underwriting their own business operations. Business owners must fully understand the operational aspects of their own enterprise and use this informa-tion to better promote their integrity and credibility to potential creditors.

The current market is characterized by businesses that require significantly more capital than is available. Due to changes in the banking model, credit is no longer synonymous with business loans, and owners are turning to whatever sources of funding they can obtain. In such a climate, business owners are advised to ensure their business credit profile is complete by working with companies like Dun & Bradstreet Credibility Corp. in order to ensure that their various business credit scores reflect their good payment history.

In these current times, banks are no longer the only sources of credit and businesses are now seeking credit in the form of trade credit from their suppliers and partners. With a significant reduction in available capital to lend, trade credit has become a more important tool for managing cash flow. However, the economic slowdown and a higher rate of business bankruptcies have moti-vated vendors to place a greater reliance on credit monitoring to assess credit quality.

This gives owners an opportunity to showcase their company’s strength to creditors in order to reduce any perceived credit risk. Those owners that do not establish and control their small business credit and do not manage their business relationships, may lose payment flexibility and may eventually have to pay cash on delivery (COD) for inventory and resources.

The changing definition of credit means that small business owners need to take a more proactive role in financing their operations. They need to do the requisite work to determine whether and how much funding is needed to expandoperations or to stave off impending business dissolution. Key business relationships must be formed well in advance of the need for capital, when operations are consistent and stable and the firm’s market reputation is strong. Additionally, business owners must understand both the operational and financial aspects of their company in order to enhance the firm’s small business credit and credibility, which in this market will have the greatest impact on the ability to obtain credit.

DISCLAIMER: This publication and the information contained herein are for your noncommercial, personal use on an “as-is, as available” basis and may be used by you for informational purposes only. Dun & Bradstreet Credibility Corp. makes no representations or warranties, express or implied, with respect to the information contained in this publication and the results of the use of such information, including but not limited to implied warranty of merchantability, fitness for a particular purpose, and non-infringement. The information contained in this publication may include technical inaccuracies or typographical errors. Neither Dun & Bradstreet Credibility Corp. nor any of its parents, subsidiaries, affiliates, or their respective partners, officers, directors, employees, or agents shall be held liable for any damages, whether direct, incidental, indirect, special, or consequential, including without limitation lost revenues or lost profits, arising from or in connection with your use or reliance on the information presented in this publication.

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