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U.S. Department of Energy Energy Efficiency and Renewable Energy

How Is Credit Risk Determined for a Small Business?

It is usually the personal credit record of the small business owners that makes or breaks the deal with a lender. Fair Isaacs Corporation, a publicly traded company, created a scoring model that has become the industry standard for evaluating consumer credit.

An image of a pie chart entitled "Components of the FAIR ISAACS Credit Score." The pie chart is sliced in the following way: Payment history 35%, Amounts owed 30%, Length of credit history 15%, New credit 10%, and Type of credit 10%.

This score, called the FICO® Credit Score, is based on proprietary formulas that include a composite analysis of an individual’s payment history, amounts owed, length of credit history, new credit, and types of credit used.

A score of 720–850 is the highest (best) category, while 500–559 is the lowest. Today, a score of 640 appears to be a common cut-off point for many commercial lenders. The underlying specifics of FICO Credit Score formulas are as secret as the recipe for Coca Cola®. The credit score’s impact on a loan transaction’s interest rate is substantial, with the lowest score costing double or more than the best score.

According to the Fair Isaac Corporation, owner of the FICO brand:

“FICO Scores are calculated from a lot of different credit data in [your] credit report. This data can be grouped into five categories [as shown in the chart above]. The percentages in the chart reflect how important each of the categories is in determining your FICO score. Those percentages are based on the importance of the five categories for the general population. For particular groups—for example, people who have not been using credit long—the importance of these categories may be somewhat different.” (Source: myFICO)

The three primary business or commercial bureau credit repositories in the United States are Dun & Bradstreet (D&B), Experian Business, and Equifax Small Business Financial Exchange (SBFE). D&B is the oldest and most commonly used credit service for business; the D&B rating system appears in the chart below.An image of a table entitled, "Dun & Bradstreet Rating System." The top row says "FINANCIAL STRENGTH (Net Worth) above the columns labeled "Rating" and "US$." In the top row, it also says "COMPOSIT CREDIT APPRAISAL" above the following labeled columns: "High," Good," "Fair," "Ltd.," and "No Info." The first item in the table: Rating of 5A; US$ of 60,000,000 and over; High = 1; Good = 2; Fair = 3; Ltd. = 4; and No Info. =5. The second item in the table: Rating 4A; US$ 25,000,000 to 59,999,999; High=1; Good =2; Fair=3; Ltd.=4; and No Info=5. The third item in the table: Rating 3A; US$ 12,000,000 to 24,999,999; High=1; Good=2; Fair=3;Ltd.=4, and No Info=5. The fourth item in the table: Rating 2A; US$ 2,500,000 to 11,999,999; High=1; Good=2; Fair=3; Ltd.=4; and No Info=5. The fifth item in the table: Rating 1A; US$ 1,200,000 to 2,499,999; High=1; Good=2; Fair=3; Ltd.=4; and No Info=5. The sixth item in the table: Rating A; US$ 600,000 to 1,199,999; High=1; Good=2; Fair=3; Ltd.=4; and No Info=5. The seventh item in the table: Rating B; US$ 345,000 to 599,999; High=1; Good=2; Fair=3; Ltd.=4; and No Info=5. The eighth item in the table: Rating C; US$ 175,000 to 344,999; High=1; Good=2; Fair=3; Ltd.=4; and No Info.=5. The ninth item in the table: Rating D; US$ 120,000 to 174,999; High=1; Good=2; Fair=3; Ltd.=4; and No Info.=5. The tenth item in the table: Rating E; US$ 60,000 to 119,999; High=1; Good=2; Fair=3; Ltd.=4; and No Info.=5. The eleventh item in the table: Rating F; US$ 35,000 to 49,000; High=1; Good=2; Fair=3; Ltd.=4; and No Info.=5. The twelfth item in the table: Rating G; US$ 15,000 to 34,999; High=1; Good=2; Fair=3; Ltd.=4; and No Info.=5. The last item in the table: Rating H; US$ 0 to 14,999; High=1; Good=2; Fair=3; Ltd.=4; and No Info.=5.

The D&B Financial Strength rating is based on the net worth or issued capital of the company. The D&B Composite Credit Appraisal is important to lenders as it provides insight into the risk of lending to (or the financial condition of) the company. A company rated “1” is considered minimal risk; “2” is low risk; “3” is greater than average risk; “4” represents significant risk; and “5” means there is insufficient information available to assign a risk category. In addition, D&B uses a model called Paydex® that tracks a company’s payment history with its vendors. A Paydex score of 80 means that the customer pays promptly. Less than 80 means that the customer pays beyond the terms (slow), and more than 80 indicates that the customer anticipates payments (e.g., takes discounts on invoices).

Experian Business Reports uses a similar system, called a Credit Ranking Score, to predict payment behavior. Customers are rated between 0 (high risk) and 100 (low risk). Equifax offers a Small Business Credit Risk Score, designed for use by the financial services industry. It uses a numeric score between 101 and 992, with a lower score indicating higher risk for serious delinquency.