Whether you are an average American or a businessperson, credit is something we all wrestle with. When you are doing business, you have to deal with both business credit and personal credit. As a small business owner, especially sole proprietors —an individual who owns an unincorporated business by himself or herself— your business finances might be linked to your personal credit. While it might seem easier to deal with one set of accounts, it’s a mistake to separate your business expenses from your personal expenses. That can cause confusion in your finances, that will affect your budgeting or your ability to assess your profit-loss precisely.
In other words, there are key differences between business credit and personal credit. In this article we will analyze both and we will learn the difference between business and personal credit.
What is Credit?
Before we can delve into the differences between business and personal credit, we must first understand credit. So, what is credit?
Credit, in its simplest form, is money you borrow from a guarantor to purchase goods or services. You agree to pay back on a later date with applicable fees and interests.
Credit can then be further broken down into many different types, such as:
Revolving credit – A line of credit that is issued with a maximum credit limit. You can have charges up to that specified limit. You must make monthly payments to pay off the balances you’ve accrued.
Installment credit – A fixed loan that is issued and you agree to pay it back in installment at a fixed payment over a set period of time.
Trade credit – An agreement where a customer can purchase goods on credit and agrees to pays the supplier or vendor at a later date. Usually, when the goods are delivered.
Here you can learn more about the different types of credit mentioned above and see examples.
Differences Between Personal and Business Credit
Now that we have unpacked the different dynamics of credit, and we have a better understanding of credit itself, lets us focus on the difference between business and personal credit. There are many similarities between them, for example, the way you build personal and business credit is essentially the same: you just have to pay your bills on time. However, there are some key differences that distinguish them apart.
1. The way they are established
Establishing personal credit, is something many of us have done in the past and will do in the future. You have to go to a bank or a credit card provider, and apply to open an account or a credit card. Through this process, the provider will ask for your Social Security Number (SSN). After you comply and you are approved, you have this account open on your personal credit because now it’s linked to your personal information (SSN).
With business credit, however, you have to first register your business as a Limited Liability Company (LLC) and apply for an Employer Identification Number (EIN) from the IRS. Then, you will have to apply for a DUNS number, a unique nine-digit number linked to the physical location of your business. It’s provided by Dunn & Bradstreet, one of the three big Business Credit Bureaus.
Once that process is completed, you must head to your bank and open two separate accounts for your business using your newly obtained EIN number: a business checking and a saving accounts.
Now it’s time to build your business profile, which is easily done by obtaining a loan from the bank you have your accounts with. You can also establish trade credit with vendors. But the most important thing is to pay your bills on time, and to make sure all of this is being reported to the Business Credit Bureaus. By doing so, you have successfully established business credit.
2. The way they calculate your credit score
Another fundamental difference between personal and business credit is how they generate your credit score. Your personal credit score ranges from 300 to 850. This number is based on information collected from your credit report by the three major consumer credit bureaus: Equifax, Experian, and the TransUnion. These credit-reporting bureaus calculate your score using the Fico algorithm. With the algorithm, they are able to look at the number of accounts you have, the type of accounts, your credit history length, your available credit, and your payment history. With all this information they generate your credit score.
Although FICO is not a credit reporting bureau, it also generates it own score, called the FICO score. This score is important because it is what lenders evaluate when you apply for a mortgage or car loan. It helps determine the interest rate offered on your loan.
Unlike personal credit score, business credit score is not standardized. Each business credit bureau (Dunn & Bradstreet, Equifax, and Experian) calculate business credit scores differently.
Dunn & Bradstreet – Focuses only on business credit, or how your business interacts with your vendors and suppliers. It uses a Paydax system to generate a score from 0 to 100. They look at the following: data submitted by suppliers, payment history, public records, and industry date. Then they create a business profile, as well as a credit score and a financial stress score. With this information they can project how a business will perform over the next year.
Equifax Credit – Collects data that shows how a small business makes their credit card and loans payments. The Equifax credit score includes payment index, credit risk score, and business failure score.
The Payment Index also scores on a scale of 100, showing how many of your company’s payments were made on time. The Credit Risk Score analyzes the possibility of your business becoming extremely late on its payments. Finally, the Business Failure Score measures the probability of your business closing.
Experian – Collects credit information from both lenders and business vendors. It takes into account your business credit score, payment trends, account histories and public records. Just like Dunn & Bradstreet, it offers a credit score from 0 to 100; however, it differs because it doesn’t just focus on payment history.
3. The way they deal with privacy and accessibility
The final two key differences are privacy and accessibility. With your personal credit score or report, no one is allowed to see it except for you and a select few. Your business credit score/report is open to the public. Anyone can get access to it if they pay the necessary fees.
By law, once a year, you are able to request a copy of your personal credit report from all of the credit bureaus. You can also request your FICO score. Not so with business credit reports: to gain access to your report, you have to pay the necessary fee to each of the business reporting bureaus.
That is it! To sum up, the fundamental difference between business credit and personal credit is that the second one is any form of credit that is linked to your personal information, like your social security number. Business credit, on the other hand, is any form of credit linked to your business through your tax ID, and its use by vendors and guarantors to rate your business ability make payments and borrow money.
Want more information about credit, or tips on how to improve your credit score? Check our blogs on the topic.