As an entrepreneur, it is your responsibility to maintain a healthy and good credit utilization ratio to enjoy long-term benefits in your business.
So, what are these benefits?
These benefits include improved credit scores, access to easier credit solutions, and better debt terms.
Here in this article, you will learn about the credit utilization ratio, the method of calculation, the impact on the credit score, and tips to manage it. Let’s read in detail and find out!
What does credit utilization rate mean?
A credit utilization ratio reflects the amount of revolving credit in use compared to the total approved by a bank or credit card issuer.
The percentage rating is the standard way it is presented. You could state that your credit usage is 45% of the available amount, meaning you currently utilize 45% of the total credit available to you. Customers who use credit accounts for both business and personal purposes follow the same guidelines for credit usage rates.
Let’s move further to understand the credit use rates for companies and how they influence the credit utilization ratio and overall financial management.
What influences your credit utilization ratio?
Your credit limits and current account balances are the two primary components of a credit utilization ratio. This is the only information used to determine your credit utilization, and we will discuss it in more detail below.
- Credit Card Usage Impact: Your whole usage rate will depend on the charge you make to your company credit card every month.
- Credit Limit Influence: Conversely, this percentage will also change depending on the credit limit a financial institution or card issuer approves you for.
Unlike your debt-to-income ratio, a credit usage ratio is calculated differently. Though these factors can be linked, your company’s revenue, assets, and credit score do not affect your utilization ratio.
How to calculate your credit utilization ratio
The equation you can use to find out your credit utilization ratio is very simple. But actually, there are complex calculations when you have more credit sources and open accounts.
When dealing with credit accounts, the usual case is that you first look at the balance, which is then divided by your credit limit. After this, the number obtained needs to be multiplied by 100 to convert the card’s credit utilization to a percentage.
Below is the fundamental formula for calculating the credit utilization ratio:
Individual Account vs. Total Credit Utilization
You can calculate the credit utilization rate for a particular account, such as a single credit card. Another approach is to add the individual account balances together and then divide them by their respective open account credit limits.
Example of credit utilization ratio calculation
The business can determine its credit usage ratio by performing this evaluation.
The company has two business credit cards, Card A and Card B.
- Card A has a $20,000 current amount and a credit limit of $60,000.
- Card B currently has a balance of $10,000 and a credit limit of $80,000.
Though they haven’t borrowed against it, the company also has a revolving open line of credit (LOC) through a local bank with a $100,000 cap.
Let’s do a separate calculation of credit utilization for each credit account using an example:
- Card A credit use rate = $20,000 / $60,000 * 100 = 0.3333 * 100 = 33.33%
- Card B credit use rate = $10,000 / $80,000 * 100 = 0.125 * 100 = 12.5%
- LOC credit use rate = $0,000 / $100,000 * 100 = 0 * 100 = 0%
For Card A, the credit use rate is 33.33%; for Card B, it is 12.5%; and for the open line of credit, it is 0%.
Finding the overall credit use rate of the company would look like this:
Total credit utilization rate = ($20,000 + $10,000 + $0 / $60,000 + $80,000 + $100,000) 100)
= $30,000 / $240,000 * 100
= 0.125 x 100 = 12.5%
The total credit use ratio for the company stands at 12.5% by comparing total credit balances with available credit limits.
The Impact of the Credit Utilization Ratio on Your Credit Score
A company’s credit score influence may serve as the primary factor companies worry about when utilizing credit. Lowering your credit usage improves your credit score report. Your ability to safely handle credit while avoiding dependence on it for business operations is reflected to lenders through this metric. The use of too much available credit may create problems for your business, as it may indicate an inability to pay back debts.
From the perspective of possible lenders and creditors, a good utilization rate remains just one of the elements that build your creditworthiness. Your corporate credit score depends on similar components as a personal credit score, such as credit usage.
Additional crucial components include:
- On-time Payments
- Total debt levels
- Length of credit history
- Credit Mix
What is a good credit utilization ratio?
Although there isn’t a precise cutoff for what qualifies as a “good” or “bad” credit use ratio, generally speaking, a lower usage percentage is better.
This implies asking for appropriately higher credit limits and using less of your current credit limit. This is not only beneficial for your credit score but also indicates that should your company require it, you have a good amount of credit available.
Experian recommends that people maintain their credit use below 30% according to their data collection as a credit reporting organization.
However, it’s beneficial to use some credit, as a 0% usage rate can negatively affect your business credit score more than using a small amount like 1 or 2%.
Tips to Improve Your Credit Utilization Ratio
Follow the below useful guidelines to start improving your credit utilization ratio:
1. Reduce Credit Card Usage
Many companies find that controlling credit card usage is the easiest approach to maximizing credit use. Once more, the credit limit approved by the card issuer is just the maximum credit you may access at once. It does not necessarily mean, though, that you should use it every month. Find your intended use rate and aim to spend only on your credit card up to this amount per month.
2. Pay Balances Early
Settling your account balance early will be effective in lowering your usage rate.
Your credit card billing date and the day your issuer reports your balance to the credit bureau might not be the same. So, even if you plan to pay off your debt, your usage could be higher if you wait until the last minute to pay.
3. Increase your credit limit
You can lower the credit utilization ratio by reducing expenses. Boosting your available credit by asking your bank or card issuer for a limit increase is another method.
Ask your bank or credit card company occasionally about the possibility of increasing your credit limit, considering your account type. While it is not a 100% sure thing, providing evidence that your financial circumstances have improved can help.
To sum up, the proper calculation method creates an easy way to determine your credit utilization ratio. Research indicates that checking your score at the right time results in several positive impacts on your financial situation. A good credit utilization score helps lenders see that you can manage credit responsibly.
Now that you know how to calculate your credit score ratio and improve it, take control of your finances and improve your financial position.
FAQs on Credit Utilization Ratio
Below are answers to frequently asked questions about the credit utilization ratio:
Can multiple business credit cards affect the credit utilization ratio?
Yes, having different business credit cards can help to reduce the credit utilization ratio of a business as long as the balances are not piled up on only one card.
How often should a business check its credit utilization ratio?
Businesses are advised to keep track of their credit utilization ratio on a monthly basis so that they can control the usage of their credit and avoid having high ratios that would reduce their credit score negatively.
How frequently is credit utilization reported for businesses?
Credit utilization is usually reported by credit bureaus each month to show the company’s borrowings and the amount of credit still available.
Does credit utilization affect relationships with suppliers?
Yes, business suppliers can check the credit utilization ratio to design the payment conditions or grant credit. The larger the percentage, the more severe the conditions could become.
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