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A classified balance sheet is essentially a balance sheet that provides more detail about a company’s assets, liabilities, and equity at a given point in time.

While many small businesses utilize a standard (or unclassified) balance sheet, you may find it useful to run a more detailed statement. Lenders and investors also typically like to see classified balance sheets vs. balance sheets when deciding whether to make an investment or approve a loan.

Here’s what you need to know about a classified balance sheet, including how it differs from a balance sheet, its pros and cons, and what formula to use.

Recommended: Guide to Business Credit vs Personal Credit

What Is a Classified Balance Sheet?

To understand the definition of a classified balance sheet, it helps to start with an understanding of what a balance sheet is.

One of a company’s three main financial statements, a balance sheet shows what a business currently owns (its assets), what it owes (its liabilities), and what the owners have invested in the business (called owners’ or shareholders’ equity).

A classified balance sheet is simply a balance sheet that divides assets, liabilities, and equity into distinct subcategories, rather than simply listing them in standard balance sheet format. For example, you might divide assets into current and long-term assets and subcategorize liabilities into current and long-term liabilities.

This more detailed presentation can be useful because it gives you more information about exactly what your company owns and what kind of debt it’s carrying. In addition, a lender may ask to see your classified balance sheet if you ever apply for a small business loan.

There are no rules as to what subcategories, or how many, you should use on a classified balance sheet. You can list whatever balance sheet classifications make the most sense for your company.

Recommended: Guide to Off-Balance-Sheet Financing

Classified Balance Sheets vs Balance Sheets

Both regular balance sheets and classified balance sheets include a company’s assets, liabilities, and equity at a certain point in time. And, both include the same totals for these three categories. However, there are a few key differences between a classified balance sheet vs. a balance sheet.

The biggest is that a classified balance sheet breaks down assets and liabilities into multiple subcategories. This can provide more insight into your ability to generate cash and sustain business operations. It can also help you make smart financial decisions, such as whether your business may need additional working capital from outside sources.

The details provided in a classified balance sheet can also make it easier for owners, investors, and creditors to calculate key financial ratios. For example, you can use a classified balance sheet (but not a balance sheet) to calculate the current ratio, which compares current assets to current liabilities to assess a company’s solvency.

Key Components of a Classified Balance Sheet

Here’s a look at some common balance sheet classifications used by businesses.

Assets

This section is often broken down into these three types of assets.

Current Assets

This includes assets that can be liquidated quickly and used for a company’s immediate needs. Current assets on a classified balance sheet may include further detail on balances for:

•   Cash

•   Prepaid expenses

•   Accounts receivable

•   Assets for sale

•   Inventories

Fixed Assets

Fixed assets are assets a business buys for long-term use that generally can’t be converted into cash quickly. Under fixed assets, you may see these line items:

•   Furniture

•   Land

•   Equipment

•   Vehicles

•   Buildings

•   Leasehold improvements

Intangible (or Other) Assets

Intangible assets might include items such as:

•   Copyrights

•   Trademarks

•   Goodwill

Liabilities

Business liabilities may break the company’s debts into three main subcategories.

Current Liabilities

Current liabilities include expenses and debts that need to be paid off within the next 12 months. A common example would be accounts payable. A classified balance sheet might also include:

•   Short-term loans

•   Accrued expenses

•   Line of credit

•   Current tax liabilities

Long-Term Liabilities

The long-term liabilities section lists the obligations that are not due in the next 12 months. This might include loans with terms of five, 10, or even 30 years. Keep in mind, though, that a portion of these long-term debts will be due in the next 12 months. Thus, this portion is always reported in the current liabilities section.

Long-term liabilities might include:

•   Long-term loans

•   Deferred taxes

•   Mortgage

Equity

Equity is the remaining value of an owner’s interest in a company after all liabilities have been deducted. This section tends to resemble a standard balance sheet and may include:

•   Owner’s capital

•   Retained earnings

•   Additional contributions paid

Pros and Cons of Classified Balance Sheets

The main advantage to a classified balance sheet is that it provides more information and insight into your business’s financial health. It also makes it easy to calculate ratios that can provide further insights into how your company is doing. Plus, if you are looking to use an investor or get different types of small business loans, you may need (or want) to provide them with a classified balance sheet.

On the downside, creating a classified balance sheet takes more time and effort compared to an unclassified balance sheet. This can result in more work for you, especially if you prepare a separate trial balance sheet to confirm the accuracy of your accounts. If you use an outside accountant, the task of creating a classified balance sheet could lead to higher costs.

For these reasons, if your company’s assets are straightforward, putting together a classified balance sheet may not be worth the trouble or expense. Also certain small business lenders, such as online lenders, may not require it.

💡 Recommended: Accounts Payable vs Notes Payable: How They Compare

Classified Balance Sheet Example

Here’s an example of a classified balance sheet for a fictional business.

Using the Accounting Equation with Classified Balance Sheets

Both a classified and an unclassified balance sheet must adhere to this basic accounting equation:

To use the accounting equation with the classified balance sheet for Company ABC above, this is what you would get:

Company ABC’s classified balance sheet follows the accounting equation and is in balance.

The Takeaway

A balance sheet shows your company’s assets, liabilities, and net worth at a certain point in time. The classified balance sheet takes that concept to the next level by breaking down the three main categories of the balance sheet into smaller subcategories (or classifications). As a result, it provides even more financial information about your business.

Large companies typically run classified balance sheets vs. unclassified balance sheets. But even small business owners can benefit from creating a classified balance sheet. Plus, you could potentially need one if you ever apply for small business loan.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

How are classified balance sheets different from other balance sheets?

Classified balance sheets break the three main components of a balance sheet (assets, liability, and owners’ equity) into subcategories in order to provide more information about a company’s financial position. Take a look at the classified balance sheet example above for more details.

What are the categories of assets in a balance sheet?

The three main types of assets on a balance sheet are current assets, fixed assets, and intangible assets.

Why are classified balance sheets used?

Classified balance sheets provide more details than standard balance sheets. As a result, they can help business owners better track their assets and liabilities and make important financial decisions. Investors and lenders often prefer classified balance sheets because they make it easier for them to analyze a company’s financials.

What is the purpose of classifying assets and liabilities?

Classifying assets and liabilities can make a balance sheet deliver information more efficiently. The categories and subcategories often help shareholders, lenders, and others assess the business’s financial condition at a glance.

Can a classified balance sheet change over time?

A balance sheet shows a company’s financial position at a specific point in time. So it will generally change over time as the business grows and market conditions fluctuate.

Photo credit: iStock/Boris Jovanovic

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SoFi receives compensation in the event you obtain a loan, financial product, or service through SoFi’s marketplace. This webpage is owned and operated by SoFi Lending Corp., licensed by the Department of Financial Protection and Innovation under the California Financing Law, license number 6054612; NMLS number 1121636. ((www.nmlsconsumeraccess.org)). This page is NOT operated by SoFi Bank. Loans, financial products, and services may not be available in all states. All loan terms, including interest rate, and Annual Percentage Rate (APR), and monthly payments shown through SoFi’s marketplace are from providers and are estimates based upon the limited information you provided and are for informational purposes only. All rates, fees, and terms are presented without guarantee and are subject to change pursuant to each provider’s discretion. The actual loan terms you receive, including APR, will depend on the provider you select, their underwriting criteria, and your personal financial factors. The loan terms and rates presented are provided by the providers and not by SoFi Lending Corp. Please review each provider’s Terms and Conditions for additional details.

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SOSMB-Q225-024

As your small business grows, from time to time, you may wish you had a reservoir of cash to draw on to cover unpredictable small needs or help tide you through seasonal lulls. Fortunately, there are at least two options that could fit the bill for your business: a line of credit and a credit card.

Both can help you cover immediate costs and can also boost your business’s credit history (provided you make your payments on time). Which is the better choice? The answer depends on your company’s individual situation and needs.

When you’re considering a business line of credit versus a credit card, there are a few differences it may be helpful to take into account. Let’s take a closer look.

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What Is a Business Line of Credit?

A business line of credit, sometimes called a commercial line of credit, is a convenient, flexible way to cover expenses like working capital, bills, inventory, and other small, last-minute expenses.

Unlike a small business loan, a line of credit gives you access to a defined amount of funding with a maximum set by the lender. You’re charged interest only for the amount you borrow, rather than on the entire amount available. Typically, you can withdraw funds from your credit line and repay as needed, as long as you don’t exceed the approved credit limit.

Business lines of credit are highly flexible, so they may be useful for many types of businesses. If your business has seasonal ebbs and flows, a line of credit may help you maintain a healthy cash flow. But even if your business is growing steadily, it can be helpful to have a line of credit to tap into if you spot an unexpected opportunity you haven’t budgeted for but would like to pursue. And if your lender reports to one of the major credit agencies, paying back what you owe on time can benefit your business’s credit rating and possibly your own.

Pros of a Business Line of Credit

A business line of credit has many potential benefits, including:

•  Easy access to funds: Compared to some other options, such as SBA loans, business lines of credit offer the borrower earlier access to money. Once you secure a line of credit, the money is basically available through your business checking account, a mobile app, or a card for you to use as needed.

•  You use (and pay interest on) only what you need: With a business line of credit, you’re only charged interest on the amount you use. And, as long as you stay within your limit, you can use the funds at will.

•  Flexibility: The funding is not purpose-specific. You are free to spend the funds for business purposes more or less as you see fit, so using the credit line can be a flexible way to address any working capital needs.

Cons of a Business Line of Credit

While a line of credit can be beneficial, it may also have drawbacks in some situations, such as:

•  Low maximums: The sum of money you have available to you with a line of credit may be less than you’d get with a small business loan. A business line of credit may not provide enough capital for a large or expensive endeavor. You may even want to compare a personal loan vs. a line of credit to see if you can get more favorable terms.

•  Short terms: A business line of credit also usually has shorter repayment terms than other options — typically three to 18 months. That means that if you withdraw a lot on your credit line, paying back what you borrowed can deplete your monthly funds quickly.

•  Variable payment amounts: The payment amount can fluctuate from month to month based on how much you owe. In addition, some credit lines come with variable interest rates. As a result, you may not have a fixed payment amount to budget for.

•  Impact on your personal credit: Any missed payments may affect your personal credit history, especially if you’ve issued a personal guarantee to secure your business’s line of credit.

When to Consider a Business Line of Credit

There are some scenarios in which a business line of credit makes sense. Some examples might be:

•  You need to pay for an expansion or other large project: A business line of credit typically offers more runway than a credit card. Credit limits may be as high as $250,000 in some cases.

•  You’re looking for a lower APR: Lines of credit tend to have lower interest rates (but, often, annual fees). Business credit cards may charge more than 20% APR for purchases — and even more for cash advances.

•  You need bridge funding during a slow period: You might need to use a line of credit to pay for inventory, vendors’ invoices, payroll, rent, or other expenses that exceed the limit on your credit card.

What Is a Business Credit Card?

A business credit card is another way a company can get access to funds as needed and pay back only what’s borrowed (plus interest). Much as you would for a personal credit card, you apply with a credit card company, and, if approved, you receive a card (or cards) that you can use to make business-related purchases. You’re then expected to make regular payments until the money you’ve taken out is paid back, with interest. Like a line of credit, a credit card will also come with a maximum, beyond which you can’t withdraw more money.

A business credit card can also be a way for your business to build its business credit (as long as you verify that the credit card company reports to one of the major commercial credit bureaus). Just keep in mind that, even if your business credit card is in your company’s name, it can potentially still affect your personal credit score. Some business credit card issuers will report late payments and serious delinquencies to consumer credit bureaus.

Recommended: Checking and Understanding Your Business Credit Score

Pros of a Business Credit Card

Business credit cards are not just for companies with big storefronts or businesses with multiple employees. Qualifying individuals who have a side hustle, such as photography or tutoring, can also benefit from them. Depending on what card you get, the benefits may vary, but they can include the following:

•  Rewards: Unlike lines of credit, business credit cards may offer perks like sign-up bonuses and/or reward systems that give you things like airline miles for using your card.

•  Relatively easy to get: Since credit card issuers often target small businesses, the cards are typically easily accessible. You may not need a business credit history of even a profit minimum. The main requirement is your personal credit history. So, even in situations where you don’t qualify for a business loan, you might still have the option of a business credit card.

•  Flexibility: Like a line of credit and other types of business loans, a business credit card will let you use the funds for any business expense.

Cons of a Business Credit Card

Business credit cards also have some drawbacks. Here are some you may want to consider:

•  High threshold for sign-up bonuses and/or rewards: While the sign-up bonuses or cash back perks may be tempting, you usually have to spend a significant amount before you can earn them.

•  Fees: There may also be a complicated fee system tied to your card. Annual fees, transactional fees, and foreign currency purchasing fees can all be included in the card’s terms and conditions, depending on which card you choose. While lines of credit may also have fees, typically credit card fees are higher.

•  High APRs: In general, business credit cards tend to have higher annual percentage rates (APRs) than many other kinds of funding, including lines of credit.

•  Payment problems could impact your personal credit score: Business credit card issuers will often report negative payment history to both commercial and consumer credit bureaus. If your business fails, the credit card company will likely view you as personally liable for unpaid debt, especially since many of them ask you for a personal guarantee.

When to Consider a Business Credit Card

A business credit card can often be a worthwhile addition to a line of credit. And there are times when a card may be a better fit for your business situation, such as:

•  You have a business credit history but no collateral: Credit cards are generally unsecured, and if your business credit score is decent, it’s likely you’ll be approved without collateral.

•  You only need to make everyday business purchases: The card’s credit limit should be able to accommodate day-to-day expenses. Plus, if the card offers rewards, those sums can be reinvested in your business.

•  You want access to the credit indefinitely: Unlike a line of credit, spending with a business credit card is not limited to a defined draw period. As long as you pay at least the minimum charge each month, you can keep the account active for as long as you like.

💡 Recommended: Startup Credit Card Funding

Key Differences Between Line of Credit and Credit Card for Businesses

Both lines of credit and business credit cards are types of revolving debt that can provide your business with the option to spend money up to a set limit. However, there are a number of key differences between them that you should be aware of. Understanding these differences can point you towards the right fit for you.

Maximums

Typically, both lines of credit and business credit cards provide smaller amounts of money than many other kinds of loans. However, business credit cards tend to have lower maximums than business lines of credit. If you’re looking for a larger amount of money, a business line of credit might be a better bet.

Interest Rates

In general, interest rates tend to be lower for business lines of credit than for credit cards. If you think you’ll end up carrying a balance, that can be an important distinction, since you’ll likely end up paying more in interest on a credit card.

Collateral

Business credit cards are typically unsecured, meaning you don’t have to provide any collateral to “secure” your debt. Business lines of credit, on the other hand, can be secured (require collateral) or unsecured (no collateral required). If you don’t have collateral to put up or don’t wish to put up collateral — and can’t qualify for an unsecured line of credit — you may want to consider whether a credit card could work for you.

Annual Fees

Both business lines of credit and business credit cards generally come with annual fees. Typically, business credit cards charge higher annual fees than business lines of credit, but that’s not always the case. Some banks offer business credit cards with no annual fees.

Cash Advances

You can usually use either a credit line or a credit card to access a cash advance. However, cash advances with a credit card tend to involve higher fees and higher APRs than advances from a line of credit. Also, you can typically get a larger cash advance from a line of credit than you can from a credit card.

Rewards

Business credit cards may offer rewards for spending money on your card, while lines of credit typically don’t offer rewards. Different cards will have different types of rewards. You might find a business credit card that offers extra cash back for spending money in certain categories (like office supplies), for example, or one that offers extra points for business travel.

While rewards can be appealing, some reward cards come with high annual fees, so you will want to make sure the rewards you’ll earn by using the card will more than make up for the fee.

Repayment Flexibility

With a credit card, there’s no official deadline for paying off the principal. The minimum payment for a credit card may be a small percentage of the balance along with interest accrued, and the account stays open indefinitely as long as you pay the monthly minimum. Also, credit cards typically have a grace period of three weeks or so before interest is charged to the account.

By contrast, with a line of credit, interest accrues right away on any withdrawal. Also, a line of credit requires you to pay off the principal eventually, in addition to the interest, within a time period defined in the original loan agreement. And once you pay off the balance in full, the account is closed and cannot be used again.

The Takeaway

Business line of credit vs. credit card — which is best? No answer fits every company across the board. Both business lines of credit and business credit cards can be valuable credit tools. Credit lines generally offer higher credit limits and lower APRs, but credit cards often come with valuable rewards and some have a 0% APR introductory period.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What is the main difference between a line of credit and a credit card?

A line of credit offers a pool of funds that can be drawn upon for larger, short-term financial needs with flexible repayment options. A credit card is designed for everyday expenses, offering convenience and rewards but often with higher interest rates if balances aren’t paid in full.

Which option is better for managing irregular cash flow?

A line of credit is better for managing irregular cash flow, such as covering payroll or seasonal expenses, due to its typically larger limits and lower interest rates. Credit cards are less suitable for such purposes because of their smaller limits and higher interest.

Can a business have both a line of credit and a credit card?

Yes, a business can benefit from having both. A line of credit provides backup for larger cash flow needs, while a credit card is useful for day-to-day transactions and earning rewards on purchases.

What are the risks of using a business line of credit?

A business line of credit may involve a number of unforeseen fees or penalties, even if you make payments on time. The lender may charge you a fee for each withdrawal or wire transfer. Some may impose payment processing fees or early repayment penalties. Worse yet, the ease of borrowing with a line of credit could lead to a cycle of debt if not managed carefully.

How does applying for a line of credit affect your business credit score?

If your business applies for a line of credit, the creditor will generally access your credit file in what’s known as a hard inquiry or a hard credit check. Regardless of your existing credit score, it will generally go down after a hard inquiry, no matter the outcome. FICO estimates that one inquiry can reduce your score by five points or less. The effect typically subsides after 12 months. Bear in mind, too, that each business credit bureau (Equifax, Experian, and Dun & Bradstreet) has its own criteria for scoring, so results may differ by bureau.

About the author

Ashley Kilroy

Ashley Kilroy is a seasoned personal finance writer with 15 years of experience simplifying complex concepts for individuals seeking financial security. Her expertise has shined through in well-known publications like Rolling Stone, Forbes, SmartAsset, and Money Talks News. Read full bio.

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q225-026

Building and maintaining business credit is an essential part of growing your company. A strong business credit score can help you secure better terms on business loans, get lower rates on business insurance, and negotiate more favorable terms with suppliers. Low (or no) business credit scores, on the other hand, may limit your opportunities.

Businesses don’t automatically start out with credit. There are several steps involved in establishing and building credit files with the major commercial credit bureaus. Read on for tips on how to build a strong business credit profile that can help open doors for your company.

💡 Recommended: Guide to Personal Credit vs Business Credit

What Is Business Credit?

Business credit is similar to your personal credit in that it tracks how well you’ve managed your credit and accounts. The key difference is that business credit only looks at how your company is managing its finances. A strong business credit history can help your business qualify for the best small business loans. Somewhere down the line, you may need an injection of capital for inventory, equipment, operating expenses, or expansion. Learning how to get business credit now could improve your odds of future loan approvals, as well as the rates and terms you get offered.

Primary Factors Lenders Consider

To understand how to build business credit, it helps to first examine the primary factors that creditors and lenders look at. Different credit agencies may calculate scores using their own algorithms. But in general, your business credit file includes your company’s payment history, credit utilization, the size of your business, and your credit mix.

Payment History

Like your personal credit score, your company’s payment history is one of the most important components of your business credit score. It shows you have both the cash flow and the systems in place to pay your bills on time.

Credit Utilization

Your business’s credit utilization compares your available credit to your actual amount of debt. If your business credit card is close to being maxed out, for example, your company would have a high credit utilization ratio. That can raise a red flag to lenders when you’re applying for small business financing.

The Size of the Business

The size of your business, and in particular its revenue, impacts your debt-to-income ratio. A large business with a higher amount of revenue can typically remain healthy even with a large amount of debt. Therefore, the lower the debt-to-income ratio your business has, generally, the better its credit score should be.

Credit Mix

Credit scoring agencies also weigh the types of debt your business holds, although it’s not as important for business credit scores as it is for personal credit scores. Even so, having several unsecured credit cards as your only type of debt may eventually impact your score, while an installment loan tied to an asset along with those unsecured credit cards, for example, may be viewed more favorably.

Length of Credit History and Its Impact

After you start a business, you may wonder how to get business credit and how long you’ll be waiting. For a new borrower, it’s likely to take at least three months to get a credit score. That’s because lenders and card issuers want evidence of your cash flow and fiscal discipline. Many creditors won’t extend loan offers to businesses less than six months old.

Step-by-Step Guide to Building Business Credit

Because your company’s growth is bound to require funding sooner or later, it’s worthwhile to learn how to build company credit as promptly as you can.

1. Establish Your Business as a Legal Entity

Before you start building your business credit, you’ll need to legally register it as a business entity. You can begin by choosing your incorporation type, such as LLC, S-corp, or C-corp. (If your business is very small, you may be inclined to stay a sole proprietor, but there are some LLC tax benefits to consider.)

Once you’ve decided, you then register with the appropriate state and local agencies. Requirements vary depending on where you live or where you are registering the business.

You’ll also need to register with the federal government by getting a federal tax identification number, as it’s required for most types of businesses. This is sometimes referred to as an employer identification number (EIN). If you’re weighing sole proprietorship vs. LLC status, note that sole proprietors need not register for an EIN; they can use their Social Security number as a tax ID for the business.

2. Open a Business Bank Account

Opening a business bank account is helpful in order to send and track payments to vendors and creditors. Consider getting accounts for both checking and savings. It might be a good time to ask your banker how to build company credit.

3. Register with Business Credit Bureaus

The three credit bureaus that track businesses and calculate their credit scores are Equifax®, Experian®, and Dun & Bradstreet®. Only Dun & Bradstreet® requires a business to actively register in order to build a credit profile. The other two automatically collect financial data when you set up credit lines with participating creditors. (You can find details about each of the bureaus later in this story.)

4. Establish Credit Lines with Vendors and Suppliers

Vendor credit and supplier credit are types of short-term financing for specific products or services. You typically receive the goods or services up front and then pay your bill by the designated due date. Typically, you have 30 days to make a payment.

Using vendor credit often appears on your business credit report, so it may be practical to choose suppliers that report your account to the appropriate agencies. Having timely payments on record can help you boost your business credit score.

Vendor credits are typically net-30 accounts, meaning you have 30 days to make a payment. If you’re new to doing business with the vendor, you may need to make a deposit or purchase something upfront.

5. Apply for a Business Credit Card

Opening a business credit card can help build your business credit, but as with suppliers, you’ll likely want to first make sure the credit card company reports to the major commercial credit agencies.

Even if your company doesn’t need the available credit, getting a card is a way to build a positive payment history. You simply make a small charge each month and pay the balance in full by the due date. Keeping your balances in check and paying off the card completely each month can help you strengthen your business credit profile.

6. Pay All Bills on Time or Early

Business credit works very similarly to your personal credit: On-time payments help improve your credit profile, while late payments can negatively impact your scores. And as with individuals, credit bureaus monitor all the accounts (known in business as credit tradelines) used by your company. That information plays a big role in determining your business credit score. So, as always, it’s wise to pay all your bills on time — or even early if you can.

7. Monitor Your Business Credit Reports

Regularly monitor your business credit reports to keep an eye on any errors that may be affecting the overall score. If an error or inaccuracy pops up on the record, follow the appropriate procedures for reporting it in order to have the issue corrected.

Establishing a File With the Major Credit Reporting Agencies

Whether you’re a new or established business, it’s important to know how to open a business credit file. While your personal credit history grows as creditors independently report your credit lines and payments, business credit works a little differently.

There are three separate business credit reporting agencies, and only two of them automatically begin collecting financial data when you establish credit with participating creditors. However, not all vendors and creditors report to the credit agencies. If you’re set on building your business credit report, you can ask your creditors if they submit payment history and to which agencies. Here’s how each agency works so you can start building your commercial credit.

Equifax®

Equifax’s business credit operations act similarly to its personal credit process. Once you establish your business and bank account, you may automatically begin accruing a history as you tap into credit opportunities, as long as the vendor or creditor reports to Equifax.

Equifax’s Business Credit Reports offer two scores — Business Credit Risk Score and Business Failure Score. The Business Credit Risk Score is on a scale of 101 to 992, with a higher score indicating a lower risk of a “business incurring a 90 days severe delinquency or charge-off over the next 12 months.” Business Failure Score aims to estimate the likelihood a business might fail over the next year. Scores for this metric range from 1000 to 1722, with higher scores indicating a lower risk.

You must pay a fee in order to access your company’s business credit file, which costs $99.95 from Equifax.

Experian®

Experian also tracks business credit history, and you can check to see if your company has an established report by using the BizVerify service. Experian’s small business credit scores run on a scale of 1 to 100. A higher score indicates a lower risk. You can purchase your full credit report for $49.95 and up to see the financial background potential creditors may see.

Dun & Bradstreet®

Unlike Equifax and Experian, you must actually register with Dun & Bradstreet in order to build a credit profile for your company there. Once registered, you’ll receive a unique D-U-N-S Number assigned to your business. In some cases, you may need to sign up for this identifier before applying for credit with certain lenders, for example if you are applying for a grant or SBA loan. Dun & Bradstreet’s credit scoring also runs on a scale of 1 to 100. Scores of 80 or higher are generally considered low risk.

Recommended: Guide to Typical Small Business Loan Requirements

The Takeaway

Building positive business credit doesn’t happen overnight, but it can help you access more competitive financing opportunities and build credibility. Important steps can include properly registering your company and understanding what type of accounts impact your credit score. Be sure to open your accounts under your business name. And remember that getting credit only helps your score if it is well managed. That includes keeping your balances as low as possible and making your payments on time.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What’s the fastest way to build business credit?

Key steps to building business credit involve choosing the right business structure, obtaining a Federal tax ID number, opening a business bank account, establishing credit with vendors and suppliers, and monitoring your business credit reports. Paying bills promptly and watching your debt-to-income and credit utilization ratios can also help.

Is building business credit worth it?

Building business credit can be worthwhile. It can help develop trust with vendors and suppliers, qualify you for competitive rates and terms on funding, and establish your credibility as an enterprise.

What credit score does an LLC start with?

A new LLC won’t start with any credit score. You need to access and use credit, establishing a payment history, over several months to get an initial credit score.

How long does it take to establish business credit?

For a new borrower, it could take at least three months to get a credit score; achieving a good or excellent score will probably take longer. Many creditors won’t extend loan offers to businesses less than six months old.

Can you build business credit without a personal guarantee?

Some credit card issuers will offer business cards with no personal guarantee. But your options are comparatively few, and you’ll probably have to fulfill certain requirements, such as revenue levels and a minimum number of years in business.

Photo credit: iStock/LaylaBird

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q225-025

Whether you’re interested in crowdfunding to start a new business or expand an existing one, this alternative method of financing can be a viable way to pump some life and energy into whatever project you’re working on. In addition to raising capital, business crowdfunding can also help build awareness and excitement about your product, service, or company.

Here’s some helpful information to know about crowdfunding, including what it is, what the funds can be used for, popular crowdfunding sites, and more.

What Is Crowdfunding?

Crowdfunding is a method of financing a business venture, project, or cause by collecting small amounts of capital from a large number of people (aka the “crowd”) through an online platform.

A crowdfunding campaign usually has a monetary goal in mind and a set deadline to reach it. Depending on the type of crowdfunding you choose, you may need to repay a loan or provide some sort of incentive to those who invest in your campaign. Financial pledges can be made and collected through the crowdfunding platform.

Crowdfunding platforms typically charge fundraisers a fee if the fundraising campaign has been successful. Many platforms operate an all-or-nothing funding model. This means that if you reach your target, you get the money; if you don’t, everybody gets their money back, and there’s no financial loss.

Recommended: 5 Crowdfunding Sites to Help Fund Your Business

When Did Crowdfunding for Businesses Start?

Modern-day crowdfunding got its start in 1997. The British rock band Marillon raised funds for its reunion tour through online donations from fans, who were eager for the band members to come to the United States.

The band’s unconventional approach to financing led to the creation in 2000 of ArtistShare, a site designed to help musicians raise money to produce albums or go on tour. ArtistShare became the first dedicated crowdfunding platform. Shortly thereafter, more crowdfunding platforms began to emerge, and the crowdfunding industry has grown consistently each year since. Globally, crowdfunding for small business startups is expected to top $2.4 billion in 2025.

What Can Crowdfunding Be Used For?

Crowdfunding offers a way for businesses or individuals to raise money online for their business, startup, new product or project, or personal cause. It can be especially helpful for entrepreneurs just starting out, who may not qualify for different types of small business loans from a bank and can’t (or don’t want to) borrow from family.

There are many types of crowdfunding for small business startups. In general the process allows users to raise money without going into debt, which is why it’s so appealing to business owners who need to save every dollar they can.

Whatever money you generate through crowdfunding, however, must be used for the exact purpose you share with your donors or investors on your crowdfunding site.

💡 Recommended: How Much Does It Cost to Start a Business?

Key Factors for a Successful Crowdfunding Campaign

The most important thing you can do when crowd funding for business is to get the word out. Raise awareness by promoting your fundraising campaign through social media, email, and word of mouth. Making the request personally to people or groups you already know can be very effective.

Setting Realistic Goals

The more modest your fundraising goal amount, the likelier you are to achieve it. This is especially important on the crowdfunding platforms that allow you to keep donations only if you reach your goal in full. The amount you specify should be enough to pay for your defined needs and not much more. It may be helpful to show investors a spending plan and production timetable to support your request.

Engaging Storytelling and Branding

Present a narrative that connects emotionally with potential donors. Talk to them in person, on video, or online to tell them about the origins of your business idea and product. You could explain not only what you are doing but also why it matters. You may want to bring in some testimonials from people who have used the product to solve a problem they had.

10 Popular Crowdfunding Sites for Small Businesses

Whether you’re looking for a small infusion of seed capital to jump-start your business or a large amount of funding to take your company to the next level, here are 10 sites that may be able to help you raise the money you need.

1. Indiegogo

Since 2008, Indiegogo (www.indiegogo.com) has helped bring more than 800,000 innovative ideas to life. It’s chock full of resources to help your campaign succeed, and you can even tap into support to help make the most of your marketing efforts.

2. Kickstarter

With more than 267,000 projects funded, Kickstarter (www.kickstarter.com) is one of the largest and best known crowdfunding sites. The funding you raise on the platform is all or nothing, meaning you don’t receive any money if you don’t reach your campaign goal.

3. GoFundMe

GoFundMe (www.gofundme.com) has a 0% platform fee and is easy to use. It’s commonly used for medical expenses, emergencies, education, or community projects, offering an accessible way to fundraise. Plus, you don’t have to reach your campaign goal to access your raised funds.

4. Mightycause

Focused on charitable giving, Mightycause (www.mightycause.com) offers individuals and nonprofits a low-cost platform for raising money for their causes. The site offers flexible options, including year-round fundraising, peer-to-peer fundraising, giving days, and special events.

5. StartEngine

StartEngine (www.startengine.com) is focused on providing a way for investors to back early-stage startups, making it a good choice for new ventures looking for seed capital.

6. CircleUp

CircleUp (www.circleup.com) focuses on companies that sell directly to consumers and offers both equity capital and credit financing. You could be partnered with investors and get help with distribution and operations.

7. Crowdfunder

If you have a Shopify store and are interested in crowdfunding a new product through your own website, the Crowdfunder app can help you do that. The app enables you to accept pre-orders from people who are interested in your idea, without paying fees to a crowdfunding platform.

8. EquityNet

If you’re interested in attracting equity investors, you may want to post your profile and business plan on EquityNet (www.equitynet.com). This platform connects entrepreneurs with a large network of angel investors, venture capitalists. and business supporters.

9. Fundable

You can opt for equity or rewards-based fundraising on this platform. Fundable (www.fundable.com) recommends the rewards option for startups seeking smaller amounts of capital that have something of value they can offer in exchange for funding. It suggests the equity option for companies that already have some traction and are seeking larger amounts of capital.

10. MicroVentures

With more than 200,000 investors, MicroVentures (www.microventures.com) connects angel investors with startups that need $150,000 to $1,000,000 in capital.

How Crowdfunding for Small Business Works

No matter which site you choose, building a crowdfunding campaign generally involves three steps. They are:

•  Creating the campaign

•  Marketing the campaign

•  Raising money with the intention of reaching the target goal. Some platforms require crowdfunders to reach their goal in order to keep any of the money raised, others do not.

Creating the Campaign

The campaign phase is where you state what you’re trying to fund and why. It could be an idea for a new business, product, or even service.

Many successful campaigners spend a lot of time making compelling, easy-to-understand videos about why financial assistance is needed and why crowdfunding is their best option. They clearly state what the money will be used for and why they need the amount that they do.

Generally, telling a compelling story can be an important step in creating the overall crowdfunding campaign. Frequently, crowdfunding campaigns convey the business owner’s personal story and their reason for doing what they do. This process is very similar to writing a business plan.

Marketing the Campaign

Creating a crowdfunding campaign is just the first step. You’ll also likely need a plan for marketing it to reach people who may be interested in supporting your business. Your “investor” is anyone who chooses to donate money to your campaign (and who is also probably your company’s target audience). Crowdfunding investors or donors can choose to fund a business, nonprofit enterprise, or project because they want early access to a particular product or service, but many simply do it because they want to help.

Depending on the type of business you run, some ideas to market and promote your campaign may include:

•  Spreading the word on your company’s website and social media channels

•  Using promoted posts on social media

•  Doing interviews for online blogs, podcasts, or other media

•  Attending conventions, business fairs, or local community events

•  Distributing flyers, pamphlets, or other promotional materials in your community

Reaching the Target Goal

Reaching your target money goal (or getting as close to it as you can) is the last phase to crowd funding for business. Depending on which platform you choose, you may or may not get to keep the money if you don’t actually reach your goal. Be sure to pay attention to these details before you choose a final platform.

However, some companies use crowdfunding not just as a source of money, but also as a way to test the market and get valuable feedback. You may be able to find out if there’s a demand for your business and what people like and don’t like about it.

Recommended: How Much Does It Cost to Start a Business?

Different Types of Crowdfunding

As a business owner, you usually have access to four basic types of crowdfunding: equity crowdfunding, donation crowdfunding, reward crowdfunding, and loan crowdfunding.

Equity Crowdfunding

With equity crowdfunding, you’re usually selling a portion of your company in exchange for money at a later date. This means that whenever your company is profitable, a portion of your profits must go to your investors. This type of crowdfunding does come with some legal tightropes to walk across, but it can be done.

Donation Crowdfunding

Donation crowdfunding is when a person donates money to your crowdfunding campaign without expecting anything in return. They do so because they respect your business or cause and want it to succeed.

Though donation crowdfunding sounds like the best, it may be the hardest to do well in. Generally speaking, people who are successful with this type of crowdfunding are usually working with a charity or tackling a social issue.

Reward-Based Crowdfunding

With reward-based crowdfunding, contributors receive a sort of reward for contributing money. This type of crowdfunding is also called exchange crowdfunding and the reward often varies based on the amount of money that is given to the campaign.

Businesses may send contributors the new product for which they’re raising funds. One of the more famous examples of this is when the Japanese game maker Yu Suzuki started a Kickstarter campaign to raise money to develop a video game, Shenmue 3. As part of the campaign, certain contributors received a copy of Shenmue 3. He originally asked for $2,000,000, but he instead raised $6,333,295.

Loan Crowdfunding

Loan crowdfunding, also known as peer-to-peer lending or marketplace lending, is when a person or company borrows money from a group of people as opposed to a bank or credit union. The money is to be paid back by agreed-upon dates and interest levels. Crowdfunding business loans may offer lower interest rates than traditional small business loans, and there is not as much red tape to work through.

Do You Pay Back Crowdfunding Money?

Whether or not you are expected to pay back crowdfunding money depends on which type of crowdfunding for small business you choose.

Equity crowdfunding: With this type of crowdfunding, investors aren’t repaid for their specific contribution. Instead, they become shareholders in the company, earning a proportionate slice of equity in the business venture. So as the company grows, you’ll be required to share a portion of your profits in dividend payments with your shareholders as long as your business is in operation.

Donation crowdfunding: You do not have to pay any money back received in a donation crowdfunding campaign. In this type of campaign, money is typically given without any expectation of a return.

Reward-based crowdfunding: You are not required to pay back any money in an exchange crowdfunding campaign, but you are expected to send your funders an agreed-upon reward once it is ready.

Loan crowdfunding: With loan crowdfunding, you are expected to pay back any money you receive. Payback dates and interest levels are agreed upon beforehand.

Regulations of Crowdfunding for Startups

The Securities and Exchange Commission (SEC) has a set of rules about crowdfunding. Startups can raise up to $5 million over a 12-month period through crowdfunding and remain exempt from the SEC’s registration process, which can be complex and cumbersome.

For small to mid-size companies, an equity offering can raise up to $75 million over a 12-month period and be exempt from SEC regulation requirements.

Pros and Cons of Crowdfunding for Small Businesses

As with all methods of financing, crowdfunding comes with its pros and cons.

Pros of Crowdfunding for Small Businesses

Here are some advantages of crowdfunding:

•  It can be a great way to test the market. If you have a business idea but you’re not sure if the market will respond to it or not, crowdfunding allows you the opportunity to turn it into a proven concept. However, if your campaign doesn’t reach a lot of investors or supporters, then it may be a sign you need to pivot your business strategy and idea.

•  The market finances your business or product. You’re not typically taking unnecessary risks with your finances by, say, taking out a startup loan. Instead, the market is taking most of the financial responsibility.

•   It can create buzz and excitement about your product. A successful campaign will generate awareness and excitement over your business and product, accelerating your past competition and years of struggle.

•  It could help you raise more than you expect. It’s possible to raise more money than you originally requested. It’s rare, but it does happen for some businesses. This is why it is so important to put everything you have into your campaign.

Cons of Crowdfunding for Small Businesses

Here are some of the disadvantages of crowdfunding:

•  It’s a lot of work to launch a successful crowdfunding campaign. It’s not as simple as signing up and telling people how much you need. For example, many successful campaigns usually end up spending money on marketing and getting a professional to shoot their video.

•  You have to find a way to reach contributors. Whatever platform you use to crowdfund typically isn’t going to advertise your campaign or make sure it reaches the right investors; this is up to you.

•  You may not get the money if you don’t meet your funding goal. With crowdfunding, you typically have to raise a certain amount of money by a certain date or you may not be able to keep any of the funds.

•  Competition can be stiff. Depending on your industry and niche, you may have thousands of campaigns to compete against.

Alternatives to Crowdfunding

While crowdfunding can be a unique and exciting way to fund your business, it isn’t for everyone. Here are some other ways you may be able to raise capital to start or grow your small business.

Small Business Loans

More established businesses can apply for small business loans through banks, credit unions, and online lenders. Small Business Administration (SBA) loans may also be available if you have trouble qualifying for traditional financing.

The SBA also offers microloans for startups. The maximum microloan is $50,000.

Venture Capital

Venture capital, also known as VC funding, is a type of equity financing provided by private investors to startups and small businesses that anticipate high growth and a need for significant funding to sustain that growth. In return for their investment, venture capitalists typically take a percentage of ownership in the company.

Angel Investors

Finding angel investors is another potential avenue for small business financing. An angel investor is typically a high-net-worth individual who offers financial backing for small startups, typically in exchange for ownership equity in the business. Angel investors could be knowledgeable and wealthy industry experts, but they might also be just friends and family who want to help.

Business Incubators and Accelerators

You can meet potential mentors and investors through a business incubator or accelerator. Incubators are generally for early-stage entrepreneurs without institutional funding; they may offer grants or loans. Typically more competitive, accelerators help established startups scale their operations; a business may be able to sell equity there to raise additional funds.

The Takeaway

Crowdfunding has become a valuable tool for small businesses to raise capital, validate their products, and engage with potential customers. By leveraging platforms like Kickstarter or GoFundMe, entrepreneurs can secure funds without traditional loans or investors. In addition to crowdfunding, other options for raising capital include venture capitalists, angel investors, and small business loans.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

Is crowdfunding good for small businesses?

Yes, crowdfunding can be good for small businesses, as it provides access to capital without needing traditional loans or investors. It helps validate ideas, engage early customers, and build brand awareness.

What is the best crowdfunding platform for small businesses?

The best crowdfunding platform for small businesses depends on the business’s goals. Kickstarter is ideal for creative projects with a reward-based model, while Indiegogo offers flexible funding options. GoFundMe is great for personal or community-driven causes, and EquityNet supports equity crowdfunding for businesses seeking investors.

Do you pay back crowdfunding?

In most crowdfunding models, such as reward-based crowdfunding (Kickstarter, Indiegogo), you do not pay back the funds. Instead, backers receive rewards or products. However, with equity crowdfunding, like on EquityNet, investors receive shares in the business. Crowdfunding typically doesn’t involve repayment like traditional loans.

How much can you realistically raise through crowdfunding?

The average successful crowdfunding campaign raises around $28,600, when all types (donation, equity, rewards, and debt) are included.

How long does a crowdfunding campaign usually last?

The typical duration is 30 to 40 days. The popular platform Kickstarter recommends a campaign of 30 days or less, but allows the user to keep going for up to 60 days.

Photo credit: iStock/Dragon Claws

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q225-021

Capital structure refers to the mix of debt and equity a business uses to finance its operations and growth. It includes long-term debt, short-term liabilities, and shareholders’ equity, which together represent the company’s total funding.

Understanding how capital structure works allows companies to make strategic financing decisions, such as determining the right balance between borrowing and issuing stock to meet growth objectives while managing risk effectively.

Keep reading to learn more on capital structure, types of capitalization structures, how to calculate capital structure, and more.

Recommended: What Is a Silent Partner?

What Is Capital Structure?

Capital structure, also known as capitalization structure, refers to a financial ratio that expresses a business’s debt versus its equity. It’s an important component of cash management and can help the business make decisions about the best way to fund future capital needs.

Key Components of Capital Structure

Equity Capital

A capital structure definition might include these types of equity:

•  Common equity: Stock owned by founders and, if applicable, employees.

•  Preferred equity: Stock owned externally. Preferred stockholders are in a higher tier than common stockholders when it comes to claiming dividends or assets.

Debt Capital

A capital structure definition might include these types of debt:

•  Long-term debt: Usually debts held for at least 12 months, which may include bonds, lines of credit, and long-term small business loans.

•  Short-term liabilities: Debts scheduled to be paid off in one year or less, which may include short-term business loans and commercial paper.

Hybrid Instruments

These financial instruments combine traits of both equity and debt, allowing for flexibility in financing. Examples include convertible bonds and preferred stock.

One important measure for assessing what capital structures are in place can be found in companies’ debt-to-equity ratio. That figure helps provide the business owners, investors, and potential lenders with an accurate picture of how the company funds its operations and what the consequences are.

Debt must be paid back to the lender, but it doesn’t change the current ownership. Equity, on the other hand, impacts the ownership structure of the business, but doesn’t need to be repaid.

There’s no right or wrong capital structure. A healthy capital structure ratio depends on the needs and goals of each individual business.

Recommended: How to Get Business Capital

Types of Capitalization Structures

Your company’s type of capital structure depends on how much debt it carries versus its shareholders’ equity. This is often called the company’s degree of leverage.

There are three types of capitalization structures: high leverage, low leverage, and balanced leverage. Each type has its own pros and cons.

High Leverage

With a high-leverage capitalization structure, a business uses more debt than equity to fund its operations and growth. Industries like insurance and banking may be highly leveraged.

Companies that are highly leveraged may be more appealing to investors eager for high returns and willing to accept a higher risk level. This is considered an aggressive form of cash flow and has both advantages and disadvantages.

Pros

•  Tends to cost owners less than equity

•  Fixed repayment schedule

•  Maintains current ownership of company

Cons

•  Lower revenue could diminish company’s profitability

•  Too much debt leads to risk of default

•  Has to be paid back, as opposed to equity

Recommended: What Is Pre-Seed Funding?

Low Leverage

A lower level of debt may seem healthier, but can have some drawbacks as well. While your business may be more stable, you may miss potential growth opportunities. But this structure may be appealing to cyclical industries, like mining, which have uneven cash flow. Investors looking for slow and steady lower-risk opportunities may prefer this kind of capital structure.

Pros

•  Greater financial stability

•  No fixed payments

•  Operational flexibility

Cons

•  Could hinder growth

•  Owner loses some degree of ownership and control

•  Paying dividends can eat into profits

Balanced Leverage

As suggested above, the proper balance of equity and debt will vary depending on your industry, business model, and particular needs. In general, though, the key is finding the mix that provides the strategic benefits of debt (such as tax shielding and a lower cost of capital) while maintaining stability, flexibility, and moderate financial risk.

Common Capital Structure Theories

Several financial theories explore how firms might decide what capital structures are right for them. The propositions deal with the proportion of debt and equity needed to finance a company’s operations. Three major theories dominate this discussion.

Modigliani-Miller (M&M) Theorem

Proposed by Franco Modigliani and Merton Miller in the 1950s, this theorem suggests that in a perfect market with no taxes, bankruptcy costs, or information asymmetries, a firm’s value is unaffected by its capital structure. The M&M theorem assumes that the cost of equity rises as a firm takes on more debt, offsetting the benefit of cheaper debt financing. In real-world applications, this theory highlights the importance of market imperfections in capital structure decisions.

Trade-Off Theory

The trade-off theory suggests that firms balance the benefits of debt, such as tax shields (deductible interest), against the costs, such as bankruptcy risks and financial distress. This theory implies an optimal capital structure where the marginal benefit of debt equals its marginal cost. Unlike the M&M theorem, the trade-off theory incorporates real-world factors like taxes and insolvency costs, making it more applicable to practical business scenarios.

Pecking Order Theory

The pecking order theory argues that firms prioritize financing sources based on costs. They prefer internal financing first (retained earnings), then debt, and finally equity as a last resort. This hierarchy arises due to information asymmetries — external investors demand higher returns due to less access to insider information, making equity the most expensive option.

These theories provide diverse perspectives on the meaning of capital structures, guiding businesses in understanding how financial allocation influences value and decision-making. In practice, firms often combine insights from all three to adapt to market conditions and strategic needs.

How to Calculate Capital Structure

Calculating the capital structure of a company is simple using the debt-to-equity ratio. This information is easy to find on the company balance sheet. To calculate capital structure:

•  First, add up all of the outstanding debt.

•  Then, add up the total amount of capital from equity sources.

•  Finally, divide the debt by the equity to find the ratio.

For instance, let’s say a hypothetical company has $500,000 in debt. Its equity is determined by subtracting the amount of liability from its assets. Let’s say assets total $750,000. We simply subtract the $500,000 debt to reveal $250,000 in equity.

By dividing $500,000 (debt) by $250,000 (equity), we find that the debt is twice as high as the equity. For every $1 the company has in equity, it has $2 in debt — meaning that the company is leveraged quite extensively.

These numbers can also be used to find the company’s cost of capital, which determines how quickly a profit can be made from an upfront investment.

What Is Optimal Capital Structure?

An ideal capital structure may mean different things to different companies. As a general rule of thumb, there should be a balance between risk and caution.

A business with a low leverage ratio may miss out on growth opportunities. So while there may not be much debt tied to the company, there is the risk of stagnation and being outpaced by competitors.

On the other hand, a highly leveraged company may barely be meeting its payments. Any revenue figures that come in under the projected numbers could cause major cash flow issues. Careful cash management is key, but high leverage can turn out well if the gamble does pay off.

Successfully investing in growth opportunities could lead to better revenue and higher net income.

One measurable way to find a business’s best capital structure is to calculate its weighted average cost of capital (WACC). This formula identifies the average cost of multiple capital sources, including debt, stocks, and bonds. The benefit of using this metric is that it helps to quantify the cost of selling equity, even though it’s used differently than debt.

Ultimately, there are multiple factors that affect the level of risk and reward associated with your company’s capital structure. When determining your business’s best capital structure, you may want to consider not only measurable formulas, but also the strength of your team and the forecasts for your industry.

What Is Recapitalizing?

Recapitalizing means changing the makeup of your business’s capital structure. Essentially, it entails either increasing or decreasing the company’s leverage. The goal is usually to provide more financial stability within the company. The two major ways to recapitalize a business are to either reduce debt or increase debt.

Reduce Debt

If a business is highly leveraged, it might pay off debt in order to reduce the payments it has to make and increase the amount of equity in the company. This can improve cash flow, liquidity, and profits. For public companies, reducing debt increases earnings per share (EPS).

In some cases, a business may also reduce debt by opting for a debt/equity swap, in which a creditor accepts equity (such as bonds for a publicly traded company) as payment.

Increase Debt

The opposite recapitalization strategy is to increase debt to achieve one or more goals. Using debt interest as a tax deduction could actually result in more tax savings.

Because debt (such as small business loans) comes with strict payment schedules, it can be used to improve operational efficiency. In a risky environment, higher levels of debt could also be taken on to deter potential takeovers.

Recapitalization is often used to make major changes in a business. Changing the balance between debt and equity can be an effective tool in restructuring your business’s existing capital structure to achieve specific goals, but the size of available business loans will depend on your company’s financial history and credit profile.

The Takeaway

Capital structure is an important metric for companies of all sizes, from small businesses to those that are publicly traded. Your company’s existing capital structure demonstrates the balance between debt and equity, which can also help you make more informed decisions about how to finance new growth.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

Why is capital structure important?

Capital structure is important because it directly impacts a company’s financial stability, cost of capital, and risk profile. A well-balanced mix of debt and equity helps businesses optimize their funding, manage risk, and maximize shareholder returns.

What are examples of capital structure?

Examples of capital structure include a business using a combination of debt (such as loans, bonds, or lines of credit) and equity (such as common stock, preferred stock, or retained earnings) to finance its operations. The proportion of each defines whether the business is more debt-heavy or equity-driven.

What are the three main parts in capital structure?

The three main parts of capital structure are debt, equity, and hybrid securities. Debt includes loans and bonds, which must be paid with interest. Equity refers to funds raised from shareholders in exchange for ownership. Hybrid securities, like convertible bonds, combine features of both debt and equity financing.

How does a company decide on its capital structure?

A company typically chooses a capital structure that’s in line with its strategic goals and risk tolerance. Other factors include the nature of its specific industry, its need for financial flexibility, its corporate governance preferences, and its tax exposure.

What happens when a company has too much debt?

A debt-burdened company may expose itself to various risks, including a drop in credit score, a rise in future borrowing costs, loss of spending flexibility due to debt obligations, and creditor constraints. In the worst cases, a debt spiral takes hold and the company could face bankruptcy and liquidation.

Recommended: Types of Business Insurance

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