Every small or medium enterprise, whether a new entity or an established one, aspires to expand its reach and operations. This growth often requires a financial boost, making business loans a common avenue for them. However, MSMEs often face challenges in accessing credit and funding, hindering their growth and development. While a meagre 14% of MSMEs have access to any credit, a whopping 51 million lack access to formal credit. Furthermore, 40% rely on informal credit, paying as much as 2.5 times higher interest rates than formal credit channels.

A primary reason for the above is that many businesses remain unaware of the critical role credit scores play in accessing and securing a business loan. To overcome this, building and maintaining a strong credit score emerges as a pivotal factor in unlocking the door to financial opportunities for MSMEs.

Understanding how credit scores work, their significance, and strategies to enhance them is essential for an MSME’s success.

What is a Credit Score?

A credit score is a three-digit numeric representation of an individual’s or business’s creditworthiness. Unlike personal credit scores, business credit scores evaluate a company’s financial health and repayment capacity. In India, credit scores are assigned by credit information bureaus such as CIBIL, Experian, and Equifax.

Credit scores range between 300 to 850. Scores above 700 are considered favorable, with those exceeding 850 classified as exceptional. Scores below 640 are often perceived as risky to the lender and associated with higher interest rates.

To provide a more precise understanding, credit scores are categorized into five tiers:

• Exceptional: 800 to 850 

• Very Good: 740 to 799 

• Good: 670 to 739 

• Fair: 580 to 669 

• Poor: 300 to 579 

Credit bureaus assess factors such as payment history, credit utilization, credit history length, credit mix, and new credit to determine a business’s creditworthiness. A higher credit score implies responsible financial management and, thus, a lower risk to lenders, resulting in better loan terms and chances of approval. A lower credit score may result in limited credit options and potentially higher borrowing costs. 

Why is a Strong Credit Score Essential for MSMEs?

A strong credit score is essential for MSMEs in India for several reasons:

1. Access to Credit: A good credit score can help MSMEs access credit at favorable interest rates and terms. This can help them meet their working capital needs, invest in new projects, and expand their business.

2. Lower Interest Rates: A strong credit score can help MSMEs negotiate lower interest rates with lenders, reducing borrowing costs and increasing profitability.

3. Improved Cash Flow: By accessing credit at favorable terms, MSMEs can improve their cash flow, which is essential for meeting their financial obligations and investing in growth opportunities.

4. Competitive Advantage: A strong credit score can give MSMEs a competitive advantage in the market, making it easier for them to attract customers, suppliers, and investors.

Factors Influencing Business Credit Score 

Several factors contribute to a business’s credit score: 

• Payment history: Timely and consistent payments demonstrate financial responsibility. 

• Public records: Tax liens or collections can negatively impact creditworthiness. 

• Length of credit history: A longer history of managing credit positively influences the score. 

• Credit utilization: The ratio of used to available credit is significant. 

• Credit mix: A varied range of credit types (loans, credit cards, etc.) can be beneficial. 

• New credit and inquiries: Frequent applications for new credit may temporarily lower the score. 

The Credit Gap in the MSME Sector 

A substantial portion of MSMEs in India lack access to formal credit. This credit gap arises for various reasons, including limited borrowing history, financial exclusion, and financial illiteracy. While large MSMEs enjoy significant revenue, the majority of the sector comprises sole proprietorships with limited resources. Consequently, only a fraction of MSMEs have formal credit access, hindering their growth potential. 

Initiatives focused on formalizing MSME bank balances and streamlining loan approval processes are crucial to bridging this gap. Expanding credit options, including unsecured lending, and offering longer repayment tenures can empower MSMEs. 

How to Build a Strong Credit Score? 

By maintaining a high creditworthiness, businesses can increase their chances of securing loans and credit lines while potentially negotiating better interest rates. Building a strong CIBIL score requires discipline, consistency, and a good understanding of credit management. Here are some tips for MSMEs to build a strong credit score: 

1. Make Timely Payments: Pay your bills and EMIs on time to avoid late payment fines and negative marks on your credit report.  

2. Keep Credit Utilization Low: Keep your credit utilization ratio low (less than 30%) to show lenders that you can manage credit responsibly.  

3. Monitor Your Credit Report: Check your credit report often to ensure it is accurate and up-to-date. Dispute any errors or inaccuracies that you find.  

4. Avoid Multiple Loan Applications: Avoid applying for multiple loans in a short period to avoid negatively affecting your credit score.  

Conclusion 

A strong credit score is essential for MSMEs in India to access credit, lower interest rates, improve cash flow and stay ahead of the competition. By following good credit management practices and maintaining a good credit score, MSMEs can achieve their growth aspirations and contribute to India’s economic growth.