For decades, small business owners have used credit cards as a tool to help finance their businesses. Twenty years ago, traditional bankers and finance professionals considered this funding method reckless, but today it has become a widely used strategy that no longer carries a negative stigma. Indeed, many business owners use personal and company credit cards to help their companies succeed.
Relying on credit cards does carry risks, however. Follow these guidelines to use them most effectively.
- Know your cards’ real costs and terms. Some credit cards’ annual percentage rates top 20 percent.
- Beware of rate and term changes. Credit card companies can raise rates and change terms without notice if provided for in their application. Even missing one payment due date can cause the APR to rise as high as 29 percent.
- Avoid using cash advances when possible. Cash advances on credit cards may carry a higher interest rate than direct purchases.
- Whenever possible, use lease financing or supplier financing for equipment such as copy machines, computer networks, computers, and office furniture.
- Use trade vendor credit when possible so credit cards can be used to fill in financing gaps where trade or lease financing is not available.
- Consider credit card financing a short-term or seasonal finance method until a more robust line of credit or other loan can be obtained. Keep credit cards in reserve for emergency use.
- Consider your cost of credit card financing when bidding work or setting prices. If you can, pass along some of the financing costs. A good rule of thumb for many businesses is to take the selling price and raise it by 2 percent. That typically covers all or most of the finance costs.
Credit card financing works well for seasonal businesses that have short but strong periods of sales followed by a few months of slow sales. For retailers or distributors of goods sold around Christmas, this can be especially valuable.
Numerous creative strategies can be employed to keep the financing cost down if your credit card starts accruing interest from the payment due date rather than the purchase date. If possible, avoid using credit cards that accrue interest from the date of purchase because even if the APR is less, you might spend more money on finance charges. The most preferable cards begin accruing interest from the date the credit card payment is due. The best cards give you as many as 25 to 30 days of interest-free financing.
One example of a creative way to use credit cards to help finance inventory costs is to purchase raw materials or inventory with your credit card and pay the minimum balance due during the 60 to 90 days it will take to manufacture your product, get it to your customer, and collect the amount due. Once the accounts receivable for the goods purchased on the card have been paid, pay off the balance. This will result in the smallest inventory carrying costs.
Avoid allowing your credit cards to “evergreen.” In other words, don’t charge the cards to the maximum limit and then pay only the minimum payment each month. This not only becomes very expensive but also greatly restricts your available credit.
Entrepreneurs are no strangers to risk, and using credit cards to finance business costs on a temporary or seasonal basis can make sense for many businesses without greatly increasing risk.
Sam Thacker is a partner in Austin, Texas-based Business Finance Solutions.