What is a credit score and what is it really used for

The credit score is an essential tool for assessing creditworthiness and the likelihood of insolvency for individuals and businesses. Used by banks and credit institutions to determine the reliability of customers applying for loans and financing, this score can also be used to evaluate the reliability of customers, partners and suppliers — even outside the strictly banking context.

Credit score: what it is and how it works

The credit score (literally “credit score”) is an indicator that describes the creditworthiness of individuals and businesses.

Used by banks and credit institutions to assess a customer’s ability to repay their debts, the credit score is generally expressed as a numerical value or a risk class. In Italy, for example, the scoring system from 1 to 1000 is widely used (with higher scores representing greater reliability), often associated with alphanumeric risk classes (AAA, AA, A, etc.) used by major international rating agencies, which today represent a kind of standard.

There is no single credit score: the Credit Information Systems (SIC) responsible for determining creditworthiness may provide slightly different assessments, and banks have an internal rating that may differ from the profile provided by the SIC.

The only score that has real decision-making value in this context is the bank’s internal rating, which nevertheless is largely based on data provided by the SIC and by the Credit Register.

How is a business credit score calculated?

A company’s credit score is calculated through a complex statistical system that takes into account a large amount of information, including revenue, punctuality of payments and the presence of any insolvency proceedings.

Among the factors used in calculating the credit score are:

• Profitability indicators, such as EBITDA or net profit, which define the company’s ability to generate profits;
• Payment history;
• Amount of debt;
• Length of credit history;
• Types of financial products (a diversified portfolio may improve scoring);
• Loan requests: excessively frequent requests may indicate instability;
• Operating context of the company: companies with a long track record tend to have a better score, as do those belonging to certain sectors and those led by managers with strong credit histories themselves.

How is the credit score updated?

Whenever a business or private individual applies for credit access (mortgages, personal loans, etc.), the bank is required to verify their creditworthiness. This verification takes place through an Hard Inquiry, a check that grants access to the customer’s complete credit profile and provides information on open loans and lines of credit, as well as payment history and, of course, the current credit score.

These data, as we have seen, are provided by the SIC, databases that operate in parallel with the Credit Register of the Bank of Italy and are designed to collect, manage and share creditworthiness information of individuals and businesses.

The credit score is a continuously updated figure: timely payment of instalments, current debt levels and any new loan applications all contribute to determining the creditworthiness level of individuals and companies, which is generally updated on a monthly basis.

What is the purpose of knowing a company’s credit score?

The credit score only describes certain economic and financial aspects of a business, without considering factors such as reputation or level of innovation, which can greatly influence the growth prospects of a company.

In other words, scoring totally ignores qualitative factors. Yet it is precisely this specificity that makes it the most effective tool for assessing creditworthiness and the risk of insolvency for individuals and companies. And its usefulness does not end there.

While it is true that banks and financial institutions use the credit score to evaluate a borrower’s ability to repay debt, investors use it to assess companies’ solidity and growth potential, while suppliers may use the credit score to determine payment terms to offer.

Knowing the reliability of a customer, partner or supplier is a crucial asset for any economic player that must take on a financial risk toward a company, whether in granting a loan or simply agreeing on instalment payments.

How to know the credit score of suppliers and customers?

Just as there are different uses of the credit score, there are also different levels of detail for describing a company’s credit profile.

An e-commerce business, for example, may settle for a simplified score that allows quick assessment of the reliability of customers and suppliers and assigns them a risk class.

A credit institution, on the contrary, needs a detailed profile that includes credit history, public risk level and the maximum amount of credit that may be granted by a financial institution.

Companies and professionals who need to assess in depth the solvency of customers or business partners will require an even more thorough credit score that provides a complete economic and financial profile of the company, including information such as past credit limits, risk score and the date of the last filed financial statement.