»Risk Management»Know How to Classify Your Business

Know How to Classify Your Business

By Marco Carbajo

It is important for small businesses to classify themselves. Two primary business classification systems are the Standard Industrial Classification Code (SIC Code) and the North American Industrial Classification System (NAICS). A business’s credit profile can be impacted depending on how a small business is classified within these systems. For example, business that is categorized in a high-risk industry may face greater difficulty obtaining financing.

How Classification Codes are Used
Lenders, insurance companies, and business credit bureaus use these classification systems to determine if a business is in a high-risk industry. Some business classification codes can trigger automatic turndowns, higher premiums and reduced credit limit recommendations on a business credit file.

Describing Your Business
Of course, a small business must not lie about what their company does, but it is possible to choose a classification code that describes the nature of the business and affords the lowest risk profile while staying within the law.

The first step to properly classifying a business is to describe its principle activities. What industry does the firm operates in? What types of products or services are being sold? These questions help determine the best classification code for the business.

SIC Codes and NAICS
In order to avoid being labeled as operating in a high-risk industry, it is important to understand how the business classification system works.

A SIC code is a four-digit numerical code used to identify the primary activity of a business. The first two digits of the code identify the major industry group, the third digit identifies the industry group and the fourth digit identifies the specific industry. For example:

The six-digit NAICS has mostly replaced the SIC code, but for business credit purposes, a SIC code is necessary because many credit agencies, including Dun & Bradstreet, still use SIC codes. A SIC code is required when setting up a business credit profile with D&B.

Industry Classifications To Avoid
Selecting an industry classification code is important is because certain industries or codes are flagged as high-risk. The following lists high-risk industry categories that should be avoided if possible:

  1. Investment (Real estate, hedge fund, lending institution, etc)
  2. Auto sales
  3. Adult entertainment
  4. Travel
  5. Restaurants

How To Avoid Certain Classifications
How exactly does a business go about avoiding the high-risk category? Suppose a small business plans on investing in real estate—don’t build credit around a real estate firm. Many banks might automatically turn you down because this is a high-risk category. You can still invest in real estate, but set up a company that does business development, business management, business consulting, marketing and advertising, or training and development. Then, the real estate investments can be operated from a separate division or company.

To overcome the challenge of being categorized as high-risk, small businesses must be creative. For instance, one of my clients owns a full-service restaurant (NAICS code 722110). He established a separate marketing company (NAICS code 541613) that his restaurant hired for marketing consulting services. As a result, he's been very successful in building credit for his marketing company despite the fact that he works primarily in a high-risk industry. 

In short, every company should assess their business classification to ensure they are maximizing their creditworthiness.

The information and advice provided by Dun & Bradstreet Credibility Corp. is provided "as-is." Dun & Bradstreet Credibility Corp. makes no representations or warranties, express or implied, with respect to such information and the results of the use of such information, including but not limited to implied warranty of merchantability and fitness for a particular purpose. Neither Dun & Bradstreet Credibility Corp. or any of its parents, subsidiaries, affiliates or their respective partners, officers, directors, employees or agents shall be held liable for any damages, whether direct, indirect, incidental, special or consequential, including but not limited to lost revenues or lost profits, arising from or in connection with a business's use or reliance on the information or advice offered by Dun & Bradstreet Credibility Corp.