There are many reasons why a company would conduct a credit search of another business. In most cases it is used to determine credit quality and the credit limits to extend to a prospective borrower. Another common reason that companies conduct credit searches is to determine trade credit terms for credit customers. Although the major reason for executing a credit search is to facilitate some type of external financing, there are other reasons why companies would require the similar business information. The following is a listing of the various reasons why companies would conduct a credit search:
Companies should conduct credit searches on their own business credit to determine how the market perceives their credit quality. A continual review of a firm’s business credit files will identify errors and omissions that can be fixed before they have an impact on business credit. Reviewing and managing a business credit file can help owners determine which operating strategies can be modified to facilitate business financing.
Trade credit is one way that businesses can increase credit sales. Providing customers with a grace period before requiring cash payments allows them to gain greater control over cash flows, and to purchase more. Businesses provide trade credit because it tends to increase the entire market for their goods and services. To safeguard the business, owners must conduct detailed credit searches and identify credit risks before extending any credit terms. Any cost to conduct credit searches will be reimbursed by limiting collection costs.
Although a firm’s vendor relationships are a source of business support, they can also provide significant business risks. A company relies on major suppliers to provide critical resources at the time they are needed. Insolvency of a major supplier can have a major negative impact on business operations, since they cannot be easily replaced in a short period of time. Many owners run credit searches on their major vendors to try and identify any financial issues before they lead to a disruption in inventories or other critical resources.
Business strategies should be designed and executed with a firm’s major competition in mind. Effective business management includes mitigating competitive pressure, which starts with underwriting the competition and their financial health. Shrewd business owners will conduct frequent reviews of their competitive set, which often includes running credit searches on them.
Credit searches are just one of the many tools that investors will use to determine a company’s value. Although lenders are more interested in a firm’s ability to cover debt service payments, equity investors want to understand a company’s ability to grow its cash flows over the long term. A credit search and a review of a firm’s business credit will provide an array of business statistics and other operating data that can be used to forecast cash flows and determine value.
Many people think that credit searches are only used by prospective creditors to determine credit quality. Since a major factor determining credit quality is a company’s ability to manage and grow cash flows, credit searches will assist anyone looking to determine the financial health of a business.