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Dictionary
Debitoor's accounting dictionary
Credit rating

Credit rating - What is a credit rating?

Credit rating refers to a number used by credit issuing institutions to assess their creditworthiness based on an individual’s or a company’s credit history and payments

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Creditworthiness refers essentially to how likely an individual or business is to pay back a debt. This likelihood is based on a number of factors, and is used to determine whether that person or business qualifies for a loan or other financing.

Naturally, a high credit rating is desirable. A high number will show that you also have high creditworthiness and will therefore be more likely to receive approval for a loan. A low credit rating shows that there have likely been payment issues in the past and will make it significantly harder to secure new financing.

Because a credit rating is tied to a particular individual or business, it is not exactly possible to ‘reset’ credit or start again from scratch. Instead, a credit rating changes over time, and there are opportunities to improve a credit rating (and perhaps even more to damage it).

What is taken into consideration in a credit rating

There are a main set of different factors that are used in determining a credit rating. These include:

  • Credit history: when you first opened a line of credit. A longer credit history is preferable

  • Repayment history: previous debts paid back in full, on time will mean a higher credit rating

  • Credit utilisation: this means the ratio between the amount you currently owe and the amount of overall credit you have available

Depending on the length of time you’ve had credit, whether you’ve been responsible in making previous payments on time, and whether you currently owe a significant amount of your total credit all contribute to your credit rating.

Credit rating for a business

In the UK, many small business owners have admitted to not having a strong understanding of what their credit rating means for their company. A UK business will have a credit score that falls somewhere between 0 and 100.

Because the credit score involves a business and not an individual the factors used for determining the credit score for a business can include:

  • Whether the business is registered with Companies House
  • The age of the business (how long it’s been operating)
  • The size of the business
  • Financial performance of the business (net worth, cash flow, debts, etc.)
  • The owner’s financial history with businesses (if they’ve previously been involved with an insolvent business)
  • Feedback from independent audits of the business
  • Trends in the industry of the business regarding insolvency
  • Receiving a County Court Judgement (CCJ) ...and more

When the credit rating of a business is being determined, these are a few of the main factors that will go into the process of determining a score on the scale between 0-100.

As with credit scores for individuals, higher numbers are preferable as they indicate lower risk to the lender. This translates to better rates for the borrower. Generally, a score between 50 and 80 indicates below average risk, while 80 to 100 are on the high end of the scale. A score below 50 indicates that the business is above average risk to extremely high-risk.

Why a business credit rating is important

Understanding what a credit score means for a business can have an impact on a number of factors. The obvious is that it can mean the difference between getting additional financing, but it also has an effect on the terms and rates that come with that financing.

However, a business’ credit rating is used in a number of other circumstances. Another main one is when a company is considering going into business with another company. Knowing the credit rating of the other business can be influential in the final decision.

Improving your credit rating

When it comes to improving the credit score of a business or individual, there are a number of actions that can be taken. Some are similar for both, but there are additional options for businesses.

Improving the credit score of a business

  • Making on-time payments (late payments will hurt your rating)
  • Reduce your credit utilisation ratio
  • Increasing your total available credit (thereby also reducing your utilization)
  • Register your business with a credit agency to ensure that it is currently on the list
  • Check on the credit rating of your main suppliers and companies you do business with regularly
  • Do not close down previous credit accounts that are already paid off
  • Keep your personal finances in check (this information can be used if there is not enough available about your business)
  • Pay off CCJs quickly (or avoid them altogether, if possible)

Managing your business finances with Debitoor

A major part of maintaining a good credit rating is staying on top of your current business accounting. This is easy with online accounting & invoicing software like Debitoor, which makes it easy to manage your income and expenses from anywhere.