Credit cards can make -- and break -- small businesses

By Emma Lunn

New businesses have a difficult balancing act. On the one hand, a fledgling operation often needs instant funds -- something credit cards can provide. On the other, leaning too heavily on credit can weigh down a business with long-term debt.

Here are some tips for walking the tightrope.

Credit cards vs. loans
A loan from a bank can be a good source of funding -- and may come with more favourable terms and lower interest rates than credit cards do. Yet, to get a loan, a business owner will likely have to produce a business plan (outlining what the loan is intended for), collateral for the loan and, often, a personal guarantee (the promise that you, the individual, will repay the loan if the business is not able to). business-credit-card

Given the difficulties in obtaining a business loan, credit cards can be a good alternative for start-up businesses.

Lucy Johnson, managing director of Small Business Cards at Barclaycard, says one of the most important benefits credit cards bring to a business is helping with cash flow.

"They provide a great way of bridging the gaps between customers settling invoices or for paying for materials so the business can start on a job," Johnson explains. "Cards are also a great way to keep track of what and where the business is spending, which can help small businesses with their record keeping." The access to credit may also help small businesses negotiate discounts with suppliers, she says.

Using a credit card for business expenses can also help you keep your businesses' expenditures organized, says Steve Gracey, spokesman for HSBC Commercial Bank.

"You can give a card to employees for travel, sustenance and entertainment expenses, and get a fully auditable statement and direct billing to the company instead of employees having to spend on their own cards and claim back," Gracey says.

Another advantage? Credit cards can help you move quickly in an emergency.

"If a van breaks down, for example, you can get it repaired immediately and pay it off the following month -- you get up to 56 days interest free - or [you can] spread the payment over three or four months," Gracey says.

The risks of credit
There's a flip side to the convenience of using credit cards for your business -- and that's the ease with which your business can get into debt.

Because credit cards make short-term borrowing so easy, some new business owners may use them without making a long-term repayment plan. If, for example, you buy an expensive piece of equipment and don't pay it off within the card's grace period, you'll wind up paying a lot more for that purchase in the form of penalty fees and interest payments. If you anticipate having difficulties paying off a large purchase within the grace period, consider getting a loan instead -- you'll likely be able to pay it off over a longer period of time at a lower interest rate.

Yet the biggest risk of using a credit card to fund your business is the damage it can do to your business's reputation with other lenders. Lenders can access businesses' credit histories, just as they can for individuals. If your business is continuously maxing out credit cards, getting more cards to fill the gap and racking up debt on those new cards as well, it will be difficult to get approved for loans in the future, thus cementing your dependency on credit cards.

Mixing business with personal
If you already have a personal credit card, can you use it to fund your business during its early days? Technically, you can -- and it might be a tempting solution for new business owners.

However, keep in mind that using a personal card for business expenses can make it difficult to keep personal and business expenses separate -- and create a bookkeeping nightmare.

An even graver risk: If your business cannot pay off the card's balance, you, the cardholder, will become responsible. Businesses, especially new ones, do fail -- and, if you use a personal card to fund a business and can't make payments, it's your personal credit score that will suffer. In addition to dealing with a failing business, you'll then find your personal life becoming more difficult as well, when you can't get good terms on mortgages, car loans or credit cards in the future.

See related: Why was my credit limit cut?, Credit card cash advances: Use only in case of an emergency

Published: 2 October 2012