Using credit cards for business capital has its advantages, but there are very clear dangers that you should be aware of to protect your business.
When a small business needs funds quickly, owners often turn to credit cards. It can be much easier for a small business to get credit cards than to go through the approval process for a business capital loan. And credit cards can be viable tools for business capital financing, especially the ones with robust rewards programs.
But using a credit card for business capital isn’t always the best strategy. Before charging business expenses to a card, make sure you understand the pros and cons of using credit cards for business capital.
Advantages of Credit Cards for Business Capital
Business owners can usually get faster access to cash with a credit card as opposed to a business loan. You can often be approved for a business credit card within minutes, while approval for a business loan can take 60 to 90 days.
Also, applying for a credit card is easier than applying for a loan, because it requires less paperwork. Most small business loan applications require you to share personal credit reports, business credit reports, income tax returns, financial statements, bank statements, and collateral. But applying for a business credit card often just requires a credit check. If your business doesn’t have much credit history, the credit card company will probably run a credit check on your personal credit.
Credit cards can provide your business with a revolving line of credit, allowing you to use the same source of funding again and again. With a business loan, after you repay it, you’ll have to apply for another loan if you need more funding.
Finally, credit cards may offer rewards based on your purchase history, such as travel perks or cash back. Those rewards can make a business credit card even more valuable, as you can use them for business purchases or business travel.
Disadvantages of Credit Cards for Business Capital
Credit cards can be helpful, but only if you are prepared to pay off what you owe to avoid paying high interest. If you don’t have a workable plan for repaying the balance each month, you can end up paying high-interest fees and getting your business into unsustainable debt.
Also, the value of credit cards depends on what you’re planning to purchase with the extra capital. Making purchases that you’ll need to pay for over a long term will cost you more with a credit card than with a business loan. The average annual percentage rate on credit cards is 17.3 percent. On the other hand, an SBA loan typically has an interest rate of 2.25-6.5 percent, depending on the type of loan.
And if your business folds, you will be held personally responsible for credit card debt tied to the business, as business credit cards require your personal guarantee.
How to Use Business Credit Cards Effectively
If you believe that a credit card is the right solution for accessing the business capital you need, there are a few important steps to make sure you’re using them effectively. First, make sure you use a business credit card rather than a personal credit card for business purchases. Even if you must provide a personal guarantee to the financial institution backing the card, you still need to keep your business and personal expenses separate for tax purposes.
Second, always have a plan for repaying the credit card balance in a timely manner to avoid high-interest fees. If possible, it’s best to only charge purchases that you expect to be able to cover with receivables in the next month. When you don’t pay off the credit card in one month, you’ll incur interest charges in the following month.
If you’re considering using a credit card to make a large purchase such as a new computer, think about opening a new credit card account with a zero percent interest rate for a limited time (such as one year). That way, you just have to pay off the purchase within that time frame to avoid interest charges.
For a small business that needs capital, a business credit card can be a viable, inexpensive option. But it’s important to understand the best ways to use a business credit card before opting to go that route.