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Back in the 1970s, the use of credit cards by consumers was an emerging phenomenon, one that would ultimately fuel the growth of the U.S. economy to unprecedented heights.
The use of credit cards by entrepreneurs, by contrast, didn’t even exist.
Except in my world.
I was a teenager up in Nantucket when I opened my first moped rental company. It started out with my customers paying all cash, but ultimately, I was able to get a merchant account because credit cards were just coming into vogue. This was great for my business because it made it more convenient for my customers.
It would also become a powerful way to fund my purchase of additional inventory. While my customers were starting to use credit cards, I was personally receiving lots of offers from credit card companies. Back then, they would mail them to you, and you just used them or chose not to. I remember one of the Visa cards had a $25,000 limit. I soon realized that I could process my own credit card through my merchant account. If I timed it right, this afforded me 55 days of interest-free money. I did this for months before it caught the attention of the FBI, which came calling. That was a rude awakening and a harbinger for what would one day be outlawed by some credit card companies — that is, processing your personal credit cards through your merchant account as a way to raise capital for your business.
While credit cards can be a valuable tool for business growth, it’s also important for entrepreneurs to understand the risks and costs as well as best practices associated with it.
Related: 8 Ways to Get the Most From a Business Credit Card
So, let’s review:
Risks and challenges of credit card usage
High interest rates:
Credit cards typically carry higher interest rates compared to other kinds of financing, such as term loans or lines of credit. Businesses that carry balances from month to month may incur significant interest charges, which can lead to long-term debt accumulation and financial strain if not managed effectively.
Debt accumulation:
An overdependence on credit cards for business expenses can lead to debt accumulation, cash flow challenges and financial instability. This is especially true if businesses exceed their credit limits or fail to make timely payments. High levels of credit card debt can negatively impact credit scores, hinder access to future financing and make borrowing costs prohibitive.
Fees and charges:
As we all know, using credit cards may subject an entrepreneur to various fees and charges, including annual fees, late payment fees, foreign transaction fees and cash advance fees, to name a few. These additional costs can erode profitability, diminish the value of rewards earned and strain cash flow if not accounted for in the entrepreneur’s budgeting and expense management.
Related: 5 Small Business Credit Pitfalls to Consider Avoiding
Best practices for credit card usage — the fun part
Strategic spending:
Entrepreneurs should adopt a strategic approach to credit card usage, honing in on essential business expenses, recurring bills and high-impact purchases that contribute to revenue generation or cost savings. By prioritizing strategic spending, while avoiding unnecessary expenses that drain cash flow, businesses can better maximize the value derived from credit card rewards and minimize debt accumulation.
Payment discipline:
Maintaining payment discipline is critical for entrepreneurs. Doing so will avoid late fees, penalty rates and negative credit implications associated with missed or delinquent payments. Obviously, entrepreneurs should strive to pay credit card balances in full and on time each month to avoid interest charges and preserve cash flow for growth initiatives.
Monitor credit utilization:
Entrepreneurs should monitor their credit card utilization ratio — the percentage of available credit being used — to ensure they are not overextending their borrowing capacity or negatively impacting their credit scores. Keeping credit utilization below 30% of available credit limits can help businesses maintain healthy credit profiles as well as improve access to future financing.
Review terms and conditions:
Before applying for or using a credit card for business purposes, entrepreneurs should carefully review the fine print, or terms and conditions. This can relate to interest rates, fees, rewards programs and liability provisions. Understanding the terms and conditions can help entrepreneurs make informed decisions and mitigate financial risks.
Related: How to Choose a Credit Card for Your Startup
A note on diversification of financing sources
Explore alternative options:
While credit cards can be a valuable tool for short-term financing and working capital needs, entrepreneurs should explore alternative financing options, such as business loans, lines of credit or merchant cash advances, which will optimize their financial strategy. Each financing option has its own advantages, limitations and suitability based on business needs and objectives.
Build business credit:
Establishing and building a strong business credit profile is essential for entrepreneurs to access favorable financing terms, secure higher credit limits and expand borrowing options beyond credit cards. By responsibly managing credit card accounts, making timely payments and maintaining low credit utilization, entrepreneurs can improve their creditworthiness and incrementally increase their access to financing.
Something I have learned over the last five decades is that credit cards can play a significant role in supporting small business growth by providing access to capital, convenience and rewards. However, entrepreneurs must balance the benefits of credit card usage with the risks of high interest rates, debt accumulation and fees. By adopting best practices such as strategic spending, payment discipline and monitoring credit utilization, entrepreneurs can leverage credit cards effectively to fuel growth and mitigate financial risks.
Additionally, exploring alternative financing options and building a strong business credit profile can enhance financial flexibility and resilience, enabling entrepreneurs to achieve their long-term goals and aspirations.