Business Credit 101 provides potential and current business owners with the necessary knowledge to successfully use credit within their business. There are many reasons why business operators rely on credit to maximize their business potential, but it is necessary to have an insight into the business credit arena to ensure that business credit is used effectively.
This course takes you through the basics of business credit giving you an opportunity to understand what business credit is, how to obtain business credit, the best type of business credit and even explores the taxation aspects of business credit. Business Credit 101 will provide aspiring and current business owners the necessary knowledge to effectively manage their business credit and financial needs.
What Is Business Credit?
To operate a business now, it is important to have a regular cash flow supported by financial income. Often that income must come from more than one source to guarantee financial solvency in circumstances when income from business either is absent or delayed.
To put it another way, if you are running a business and the profits from that business are not immediately in place, you will need to find other sources for income. This usually comes in the form of a loan from an external source, generally a business bank or financial institution, that is paid back over time. Just as an individual can borrow money to serve a need or enable an acquisition, known as personal credit, a business can do the same. This is business credit.
It is now an accepted approach for most businesses that are looking to increase their market share to obtain business credit. In large part, this is done at the outset of a business, when the business owner looks to give the company a jump start in its market by borrowing capital that can be used to pay for staff, source goods, premises, or any other necessity in order to get things moving.
Once a company is up and running, the hope is that its financial needs will be served by its income from business, meaning the people using the service. However, while the company is in its infancy, it is easy to be crushed by the competition. To serve the necessary costs of a young business, credit is often an unavoidable necessity.
Of course, there is inevitably some risk to taking out a credit-based financing option. The success of such an option depends very much on the business becoming profitable. Like all loans, a business loan needs to be paid off in full at some point, and in monthly installments in most cases. These repayments will generally be made out of the profit of the company.
Interest-free credit is a rare luxury, so you will end up paying back more than you borrowed; but the idea here is that the credit acts as a financial stabilizer for the company while it gets up and running. Then, when you have been doing business for long enough, with a markup on your initial layout, you will be able to make the repayments and still have enough money coming in to keep the business solvent.
It is not just on starting up that a business will require or request credit. Companies often take out a loan at other times. One example is when a business is experiencing a cash-flow crisis and not making enough money from product sales or service users to keep operating at the usual level. In such cases, a loan can provide a kind of financial bridge. This has been seen in recent times in its most extreme form with the financial stimulus plans being rolled out by governments across the world. Banks and other businesses were at risk of failing, and the governments released money in order to allow these companies to keep operating until things improved. Once again, the importance of business credit is to allow companies to remain operative while things are difficult.
A company cannot go on applying for business credit indefinitely, of course. By its very nature, business credit needs to be a temporary solution. It is no substitute for operating at a profit because, simply put, if you are not making money, then you will not be able to pay back the loan that you have received.
For a company, then, business credit will be required from time to time in order to enable the company to operate off its own profits. If it becomes clear that the company will not do this and cannot pay off even the initial credit, then the company will end up bankrupt, unable to meet its debts, and unable to continue operating. This is a demonstration of the risk of business credit and the fact that it should be taken out only when needed to either keep the company solvent or enable it to operate at a higher level that ensures the company's ability to make payments on its business credit plans regularly and in full.
Business credit is usually received in the form of a loan. There are different kinds of loans, but the most common one, and the first a company will pick up in its lifetime, is a start-up loan intended to provide money for supplies, wages, and other costs that will later be covered by business profits. Later on, a company can take out a working capital loan that enables it to meet costs in the short term in order to continue operating. Working capital loans can be unsecured if the applicant has a good credit rating and is likely to be able to pay the money back without difficulty, or secured, whereby the company needs to offer assets to the bank in order to provide security against a default.
There also are loans that can be secured against the product that they were borrowed to buy, meaning that if the company fails to meet repayments, the equipment falls into the hands of the lending institution, which may demand its sale and/or ask to be paid the money that the equipment has made for the company. The same principle applies to a commercial real estate loan to buy business premises. This type of loan works in very much the same way as a mortgage to buy a house.
The above are just a few examples of the kinds of credit a business can apply for out of a very wide range of options. Many of the rest will be covered in later units of this course, contributing to a wider and more complete understanding of what kind of business credit suits a given situation.