First, let me say unequivocally, the use of personal credit cards can be a very risky means of financing business operations. MasterCard and Visa weren't designed for this purpose. However, with some creative planning and both eyes open to the costs involved, personal credit cards can temporarily fill the gap between raising startup capital and successfully ramping up the company to positive cash flow.
Second, let me also clarify that the use of credit cards should be replaced as soon as possible by more traditional bank financing and/or leasing arrangements, once the firm has reached the break-even point and monthly sales receipts can cover normal COGS (cost of goods sold) and overhead expenses.
There are two basic categories where credit cards could be used for the emerging small business as part of a larger financial plan. The first category is for asset acquisition, when the firm needs to secure telephones, a fax machine, a copier, PCs, printers, mobile phones, scanners, and any other unique equipment and devices to execute the business operations. Virtually every item here can be had for little or no money down and relatively small (and manageable) monthly payments spread out over time (normally 24 to 60 months). Large office-supply stores and outlets typically offer special payment terms for their own credit cards as well as personal credit cards.
The key rationale in this strategy is that the business owner is weighing the current utilization of the equipment and the present value of tangible productivity gains against anticipated future sales. Projected revenues are coming in perhaps three fiscal quarters, so even at a 15 percent annual credit rate (1.25 percent monthly), six to nine months of carrying a balance will only cost the entrepreneur between 7.5 and 10 percent in addition to the sticker price for these assets acquired. Paying back just the fully amortized "minimum due" over 24 to 60 months would add anywhere from 40 to 75 percent to the final cost, but the plan is to pay these balances off with the first few rounds of revenue.
Another way to do this would be to make minimum payments for four to six months and then pay off the balance in full through a balance transfer with another card that, as of yet, has no outstanding principal. Some cards might even offer a low promotional rate for three to six months on such balance transfers. Remember, this is simply a means to buy some time until consistent sales are realized. But it can be devastating if sales levels never happen as planned and the principal balances have no way to be paid in full.
The second category for credit card use is working capital, or cash-flow management. For example, when COGS are charged to a credit card, the sponsoring bank may extend a 30-day grace period until the principal balance is due. The firm may be able to synchronize the account receivable from the buyer to match that 30-day time period, so the business can pay the balance at or close to that due date.
Another strategy is to carry an outstanding COGS charge balance for a completed invoice for the 30 to 90 days until the buyer pays. Making the minimum payment due during that time means the total cost to carry that receivable will only be 3.75 to 5 percent until the principal can be paid in full. And the firm may also be able to build that percentage "carrying cost" into the company's pricing and gross profit margin.
One sequence of credit card use could look like this. The firm makes the payment on COGS with credit card No. 1, then pays the balance in full 30 days later with credit card No. 2 and avoids any interest charges. The firm then pays that carried-forward balance in full 30 days later with credit card No. 3 and has gained 60 days total time for the buyer to pay the invoice. The ultimate goal is to have access to cash to acquire needed assets now and to pay bills on time--but remember to view the credit cards as a temporary measure to get the firm out to the point of consistent revenue. Once the company's sales stabilize into regular monthly receipts, the entrepreneur should secure traditional loans for assets and a line of credit for working capital through a commercial bank.
David Newton is professor of entrepreneurial finance at Westmont College in Santa Barbara, California. He is the contributing editor on growth capital for Industry Week Growing Companies and a moderator on small-cap stocks for eRaider.com. His books include Entrepreneurial Ethics(Kendall-Hunt) and How to Be a Small-Cap Investor(McGraw-Hill), named November 1999 book-of-the-month by Money magazine and a 1999 Top 10 book by Forbes. His latest book is How to Be an Internet-Stock Investor (McGraw-Hill). He has written or contributed to more than 80 articles for publications including Entrepreneur, Your Money, Business Week and Solutions, and has been a consultant to emerging, fast-growth entrepreneurial ventures since 1984.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.