Your business credit score is the magic number that will dictate the future of your borrowing – and potentially your entire company. It’s therefore crucial to understand how your score is shaped, so you can take appropriate steps to reduce it – resulting in easier access to credit at lower interest rates.
But isn’t the algorithm behind your credit score a closely guarded secret? Yes and no. Whilst none of the major credit bureaux openly reveal their formulae, it is known that the FICO algorithm used to calculate it is based on five key factors. One of the most important is credit utilisation.
All about credit utilisation
As the name suggests, credit utilisation measures the level of credit you are actually using in relation to your total credit limits. This can apply to all kinds of business credit, from loans to overdrafts to credit cards. But how is it calculated?
You might, for example, have an overdraft with a limit of £25,000, of which you’ve drawn down £10,000, and a credit card with a limit of £15,000 and spending of £9,000.
Your total limit across these forms of borrowing is therefore £35,000 and the amount you have outstanding is £19,000. As a result, you are utilising 54.2% of your available credit.
How is your credit score calculated?
To answer this question, we need to look at the FICO algorithm in more depth and how it leads to the calculation of your credit score. Your credit score is compiled from your credit report, which is essentially your company’s timeline of borrowing and repayment. In particular, it will highlight how responsible your financial behaviour is – whether, when you borrow money, you repay it on time and in full.
Each of the major credit bureaux collect this information in slightly different ways and at slightly different times, meaning that your credit report will vary somewhat. However, they all utilise the FICO credit score, which distils reams of complex information into a three-figure number between 350 and 800. Potential lenders will use this score to assess your reliability as a borrower.
The algorithm uses the following five factors to calculate your score:
Payment history. Making up 35% of your score, this assesses whether you pay back your borrowing on time and in full. The more lines of credit you have taken out and repaid, the better.
Amounts owed. This is where your credit utilisation ratio comes in – 54.2% in the case of our scenario above.
Length of credit history. How long you have been taking out credit contributes 15% to your credit score.
Credit mix, assessing the different types of borrowing you have (with some being considered riskier than others). This factor contributes 10% to your credit score.
New credit. The final 10% is based on the number of new credit lines you have open. In other words, if you’ve taken out lots of new borrowing lately, that’s a huge red flag and will damage your credit score.
So how can credit utilisation damage your credit score?
Making up 30% of your total credit score, your credit utilisation will significantly affect the ways in which you can borrow – not to mention the cost. If you have a high ratio – substantial borrowing compared to your limits – lenders will consider this a warning that you may not be able to service any more debt. As a result, higher credit utilisation ratios correlate with lower credit scores (though if you have no credit utilisation at all, this will also depress your score).
So what’s the ideal level of credit utilisation? Under 20% would be perfect and under 30% reasonably advantageous, so in our example above the business in question is likely to take a significant hit on its score. But if your utilisation isn’t where you’d like it to be, what can you do about it?
How to enhance your credit score
The bad news is that …
