Using Credit Cards as a Financing Tool? What You Need to Watch Out For

small-business-debtMost business start-ups can’t get to the starting line without some sort of financing. While there are many ways entrepreneurs can finance their ventures, credit cards are used in many cases as much for their convenience as for the lack of access to other forms of financing. While there are some amazing tales of how mega-companies were launched using credit card debt, there are thousands more accounts of entrepreneurs who were forced into bankruptcy under the crushing weight of maxed out credit cards. Most financial experts advise against using credit cards as a financing tool, but if you decide to use them, consider the following:

Protect Your Credit

Obtaining credit as a start-up is almost always reliant upon the personal credit worthiness of the business owner. If credit cards are going to be a source of financing, provide short term cash flow or a contingency funding, it is important to monitor your credit balances and make all payments on time. This is a risky and expensive way to start up a business, so you don’t need to have your credit card companies raise your rates into the stratosphere due to a late payment or over-limit charge. Keep your balances as low as possible to ensure that you have the funds available when you need them and pay it off as soon as possible.

Using Credit Cards to Fund Inventory

With some cards charging as much as 29% interest, carrying a large balance over an extended period of time can eat into the revenue that was expected to repay the debt. The best strategy for credit card financing is to use it as means to cover the cost of doing business to create a specific stream of revenue. For example, you may acquire a new customer who places an order with you for a product or service that will generate $15,000 in revenue over the next four months. In order to deliver the product or service, it will cost you $5,000 in materials. You might consider financing the $5,000 with a credit card in anticipation of repayment using the revenue from the sale. Your cost of doing business is increased by the financing charges, but only for a limited period of time. Before doing this, however, make certain you have a solid expectation that you will be paid by the customer and try reducing your outlay by getting a deposit upfront instead.

Using Credit Cards for Equipment Acquisition

In some cases, a business requires certain equipment or materials just to be able to open the doors. This could include office equipment, computers, software, or production materials. If credit cards are used for these purchases, the debt can remain on the cards for quite a while, thus substantially increasing the cost of acquisition. And if these purchases run up large credit card debts, there may not be credit available for short term cash flow emergencies. 

A better way to finance this type of start-up cost is through leasing or with an equipment loan. The interest rates are generally much lower and they have fixed terms which insures that you will pay it off in a reasonable period of time.

Summary

Using credit cards to finance business needs is can sometimes work as a strategy if they are used with extreme care and effective management…but it is a dangerous financial strategy that can wreak havoc with your finances, so proceed with extreme caution and monitor the costs closely.  And, as these credit cards may be either personal cards or personally guaranteed by you, there is a danger of hurting your personal credit score which could harm your chances of obtaining additional credit later or raise your interest rates.

Credit cards should only be considered as a short term financial bridging solution for business activities that will generate the revenue needed to repay the balance plus interest.

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