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More and more banks and financial institutions are using credit scoring models to analyze the risks associated with lending to small businesses. This has interesting consequences on the availability of credit for small businesses and business start up projects that usually lack the funds and the financing needed to successfully develop and take too long to expand whereas with the proper financing such processes could take only a year or two at most.
A proper financing system for small businesses could generate even more employment than what they already provide (they account for almost half of the private job positions in US). Therefore it is both interesting and encouraging that the use of a specific credit calculation system for businesses contributes to a healthier economy.
The Uses of Small Business Credit Scoring
The credit rating that evaluates businesses is used for considering application for many different business financial solutions. This includes: Business Loans and Lines of Credit, Equipment Leasing for businesses, Invoice Factoring (Cash Flow Aid), Business Sales and Acquisitions, and many other financial solutions for businesses.
Before the business credit assessment system, a long credit and financial verification process was needed every time that a financial product had to be approved. Though the processes remain long, they are improving and the speed slowly resembles the swiftness with which banks and financial institutions provide unsecured financing for personal purposes.
How Is Small Business Credit Scoring Cooked?
The scoring system just like consumer credit assessment system is based mainly on credit history. However there are some differences that need also be considered. For instance, the actual credit score and history of the owner or owners of the business are part of the small business credit score. This is due to the fact that small companies are too dependant of the owners, especially when the business needs capital contributions.
Therefore, when it comes to small companies credit scoring the first information collected is data on the owners provided by consumer credit companies: outstanding debt, credit lines used and unused, delinquencies, etc. Secondly, there is data on the company that is obtained by the financial institution starting on the information you provide during the loan or line of credit application and information on the company can sometimes also be provided by commercial credit bureaus.
Of course, that’s not the end of it, in order to obtain the scoring system all the variables included in the data obtained are processed through an algorithm or formula that includes the variables. No more than fifteen variables and no less than seven are included in these formulas that help banks and financial institutions standardize the decision making process of commercial loan and credit line approval.
Small Business Credit calculation has gone a long way improving the access to credit for small companies and the results are very promising. The first third party credit scoring system was provided in 1995, seven years later almost all financial institutions providing commercial loans and other financial products make use of third party’s or proprietary assessment systems and fortunately the availability of funds for small firms has increased amazingly.
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