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What is Credit?

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Credit Definition & Meaning

Updated: November 25, 2022

Running a small business is difficult.

There are a number of issues that can come into play when managing a company. But the most common issue to struggle with is a businesses’ finances.

There are a number of ways to raise capital against a business. One of the most popular ways is via credit.

But what exactly is credit? And why do so many business owners make use of it?

Read on as we take a look at the definition of credit, and the different types of credit that you can make the most of.

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    KEY TAKEAWAYS

    • Credit is typically defined as a contract whereby someone borrows something of value to then will repay the lender by an agreed-upon date.
    • Credit can also be referred to as someone’s viability in being trusted to repay a lender within the agreed terms.
    • Someone with a good history of credit can be referred to as ‘creditworthy’ or having ‘good credit’.

    What Is Credit?

    Although a broad term with many definitions, credit can typically be defined as a payment contract between two parties. The borrower receives something of value, to then repay the lender by an agreed-upon date. The borrower will generally be charged interest on the amount payable. 

    Additionally, the more of these interactions a borrower has will affect their ‘creditworthiness’. This is also often referred to as having good/bad credit. This will help lenders or a financial advisor determine whether they can trust that the value will be paid back promptly in a report to business. This will be alongside any additional financial charges such as interest. 

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    How Does Credit Work?

    Credit works by having an agreement with a lender. Under this agreement, you will obtain goods or services from someone else. You will then pay for these goods or services at a later date under the agreed upon terms. 

    For example, if you buy goods from a trader on a weekly basis, you can open a line of credit. At the end of the month you will pay the accumulated balance. Or a simpler example is bank credit. You could have bank credit card accounts where you pay for goods with the card. You then pay the bank back at the end of the month. 

    Most Popular Forms of Credit

    Installment Credit

    This is the most popular type of credit. It includes car loans, signature loans or mortgages. Simply put, this is when the lender credits money to a borrower. Entrusting that they will pay it back at a later date, or face legal/financial penalties. These payments are typically equal monthly installments.

    In other cases, financial sources are not the only type of credit. For example, if a shop takes a bulk order and is later invoiced, the supplier is offering a type of credit. 

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    Revolving Credit

    This is when you are given a borrowing limit. With revolving credit, you must make a minimum charge each month, and can then charge up to your credit limit. Most credit cards are a type of revolving credit. If a partial payment is made, you will then carry the remaining balance onto the following month. Alternatively, you can revolve the debt. 

    Service Credit

    Most service provider contracts are done via a credit agreement. Services such as gyms, internet providers, etc will provide a service to then be paid monthly in order to continue use. 

    Some modern credit scoring systems will consider this when calculating your credit score.

    Credit in Financial Accounting

    In terms of financial accounting, a credit is an account entry. This will record the sum that is being received. 

    For example, if a company were to buy merchandise on credit, the company’s inventory account would increase by the sum of the purchase. This would add an asset to the company. However, its accounts payable field (bills that are due) will then increase by the same amount, adding a liability to the company.

    Summary

    Credit is a great way to raise capital for your business. It is a relatively safe and reliable way to raise the money that your business needs. Just as long as you don’t have a bad credit history, or a history of bad business practices. The most important thing is to make sure you’re not taking on more debt than your business can handle.

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    FAQs on Credit

    What Is a Credit Score?

    A credit score is a number given to you between 300 and 850. This will determine your creditworthiness. The higher, the better it looks to potential lenders.

     

    What Is My Credit Score Based On?

    It is based on your credit history. Ie, your repayment history, your outstanding debts, length of credit history etc.

    How Long Does a Bad Debt Stay On a Credit Report?

    Most debt or negative credit information will stay on your credit report for 7 years. However, more extreme cases such as bankruptcy can stay for up to 10 years. People can make use of a credit repair company to help with bad credit. 

    Why Do I Need Credit?

    If you plan on borrowing money for any large purchases, such as a car or a home, or even for a business loan, good credit is vital. A higher credit score can also mean lower interest rates on your credit card or loans. Often high credit can even help with insurance rates. Many companies also use rewards programs for those with great credit. 

    How Do I Get a Credit Report?

    There are three national credit bureaus. They can provide people with free annual credit reports as public assistance. They also can provide a personalized recovery plan. Applications for credit reports can be made from:

    • Equifax
    • Experian
    • TransUnion

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