If you're a small business owner, you've probably received numerous offers and applications for a small business credit card. You probably wonder whether you should consider getting one or how they differ from other forms of credit. According to Creditcards.com, as of 2015, about 67% of small-business owners currently have a business credit card; there are 13.9 million small-business credit card accounts in the U.S., and they account for $430 billion in spending.
A business credit card can be a convenient way to quickly access financing for short-term needs and can increase your company's purchasing power. In fact, 37% of small business owners reported using credit cards just that purpose, second only to a traditional line of credit, according to a National Small Business Association study. However, like any source of financing, a business credit card comes at a cost and must be carefully managed.
What They Are
Small business credit cards provide business owners with easy access to a revolving line of credit with a set credit limit in order to make purchases and withdraw cash. Like a consumer credit card, a small business credit card carries an interest charge if the balance is not repaid in full each billing cycle. You may be able to get a credit card through your bank or you can compare cards terms and features – and apply online – through our credit card tool.
Credit Card Vs. Line of Credit
Small business credit cards are marketed as an attractive alternative to a traditional line of credit, but there are some important differences.
The first and most obvious is that a credit card provides you with a revolving line of credit for your business whereas a loan or line of credit carries a fixed interest rate. That means that you can continue to borrow or charge up to your credit limit as you repay your monthly bill when you use a credit card, compared to a fixed line of credit which requires that you apply for a new loan once you have used and repaid your first loan.
Another important difference is the amount of money you can access and the amount of interest charged. Traditional small business loans or fixed lines of credit typically provide a larger amount of financing, which is necessary for more substantial purchases such as equipment leasing and facility costs. These loans cost less because they charge a lower rate of interest.
Lastly, unlike most loans or fixed lines of credit, small business credit cards do not require that the card holder put up collateral to qualify for the line of credit. Credit cards represent an unsecured form of borrowing, meaning that the loan sums are not guaranteed by an asset of the borrower's. Instead, the card includes a requirement for the card holder to sign a personal guaranty, meaning that she or he is personally and legally liable for repaying the money borrowed on the card. (For more on this read Asset Protection For The Small Business Owner.)
Business Credit Card Pros
Along with providing necessary cash flow to help maintain and build your business, credit cards can offer these advantages:
Easier Qualification: It can be easier for business owners who do not have a well-established credit history to qualify for a revolving line of credit with a credit card, rather than a traditional line of credit or bank loan.
Convenience: Credit cards are the ultimate in financing convenience. Business owners can quickly access funds for purchases or cash withdrawal, much more easily than having to find cash and/or use a checkbook.
Financial Cushion: A credit card can provide business owners with a much-needed financial "cushion" when accounts receivables are behind or sales are slow and the business is short on cash.
Online Ease: Increasingly, business owners make purchases and do business online with vendors, contractors and suppliers. Using a credit card makes online transactions easier.
Financial Bookkeeping Assistance: In addition to receiving a monthly statement, most cards provide small business card holders with online record-keeping tools to manage their accounts, including a year-end account summary which can help a bookkeeper track, categorize and manage expenses. It can simplify bookkeeping, help when using outside professionals to navigate an audit and pay taxes, and provide an easy way to monitor employee spending.
Rewards and Incentives: Many cards offer business owners rewards programs – including airline miles and shopping discounts – for using the card. Some also provide "cash back" incentives, repaying card holders a percentage of their purchases. (For more information read Credit Card Perks You Never Knew You Had.)
- Tool to Build Credit: Responsibly using a small business credit card – which means paying the bill on time, paying more than the minimum due, and not going over the credit limit – can be an easy way in building up a positive credit report for your business. That, in turn, can help you be more likely to qualify for a loan or line of credit, and at a potentially lower interest rate, in the future. (To learn more, see 5 Ways To Raise Your Business Credit Score.)
Business Credit Card Cons
Before rushing to apply for a business credit card, it's important to consider these potential downsides:
More Expensive: The convenience and ease of small business credit cards come at a price: They typically charge a much higher interest rate (1-3% over prime) than a small business loan or fixed line of credit offered by a bank. That interest can add up quickly if card activity is not repaid on time and in full each month. In addition, without a system to regularly and carefully monitor card usage it can be easy to accidentally overextend your firm financially by going over your firm's credit limit or incurring late fees or penalties. (For more on this, read Six Major Credit Card Mistakes.)
Personal Legal Liability: Most small business credit cards require a personal-liability agreement (your personal security) to repay debt. This means that any late or nonpayment could result in a negative personal credit report and the inability to personally borrow money. You also may have to pay more with a higher interest rate.
Security Issues: Security measures should be created to ensure that cards or card information is not stolen by employees, vendors, contractors and others who come through the office space. It's also important to make sure that employees that are authorized to use the card do not use the cards for personal spending, and that they take precautions when making online transactions to avoid being hacked.
Less Protection: Often, small business credit cards do not carry the same protection as consumer credit cards. For example, many cards will not provide the same level of assured services when disputing billing errors or needing to make merchandise returns. Be sure to review what level of protection and services a card offers before applying.
- Fluctuating Interest Rates: Unlike a loan or fixed line of credit, the company that issues your credit card can reset the interest rate on your credit card depending on how you use and manage your account.
Using a Business Credit Card Effectively
Without a good system in place, it can be difficult to keep track of – and keep a handle on – credit card spending, which ultimately affects your bottom line. Here are some strategies to responsible ownership.
1. Ensure Accountability
"The most important step a small business can take to make sure credit cards are used effectively is to set up a bomb-proof accountability system," says John Burton, CEO of Moonshadow Learning Services, a leadership development company near Asheville, N.C. "This could mean everything from pre-approval of all credit card spending, to rigorous requiring of receipts, to pulling credit cards from those who do not report completely and on time with receipts," says Burton.
Have a system in place before the first credit card arrives and, Burton says, be consistent, rigorous and fair, and tolerate no exceptions. "If there is a policy of requiring all accounting and receipts to be turned in by the 10th of the following month, say, have a 'no exceptions' policy," he emphasizes. "This raises everyone's awareness about how seriously the company takes stewardship of its funds. Giving someone a credit card with a $5,000 spending limit is like handing them a blank check."
2. Decide Who Gets a Card
Burton acknowledges the challenges employers may face in deciding who gets a credit card. "I've seen businesses that lost control of credit card spending by issuing too many cards to too many people, and thinking that all important officers and travelers needed the convenience of a company credit card," says Burton. While giving everyone a credit card might seem like the right or easy thing to do, it can lead to a "dysfunctional, expensive system, and a serious lack of control and accountability," he explains.
Use alternatives and establish rules. "Many companies, especially with sales people, reimburse for company spending on personal credit cards with excellent accountability – i.e., no receipt, no reimbursement," says Burton. It is helpful, however, to have clear rules regarding who gets a card, whether it's based on seniority, position or some other factor(s). This can help avoid confusion and mitigate bad feelings from employees who would like a card, but are not eligible.
3. Set Limits
Every business should have clear policies about spending, including which expenses can be put on cards, how much employees can spend and how often they can use their cards. It's important to put the policy in writing, and have every employee who is issued a card read and sign it. After they do, give each cardholder a copy to use for reference.
"Potential credit card users should know the rules on pre-approval of spending and when it's okay to use a company card," Burton says. If your business doesn't have a clearly stated policy in place, it can become easy for credit card users to justify any expense, even those you didn't intend to cover. "You have to specify if it's okay to spend on alcohol at a meal, if there's a limit on meals, the dollar limit above which non-routine approval must be obtained, and if a staff person gets meals paid for on non-overnight travel," says Burton.
Depending on the business card, you may be able to set up restrictions that limit transactions to a certain dollar amount, spending category, and even certain days and times. With some cards, you can set up individual restrictions for each employee. For example, you may limit one employee to $50 a day any day of the week for gas purchases, while limiting another to $100 for gas and $50 for meals each day, but only on business days.
4. Be Watchful
Many business credit cards allow you to set up activity alerts that arrive as text or email messages. The alerts can be set up to notify you each time a transaction takes place, or only if an employee uses (or tries to use) a card in an unapproved manner. You can also take advantage of online and/or mobile banking to view up-to-the-minute account activity. It goes without saying that you (or your accounting department) should review each statement to make sure each line item is a charge you authorized.
5. Use Credit Wisely
While credit cards are easy to use, they're not always the best choice, especially for large expenditures that can't be paid in full before interest kicks in. "If a business uses a credit card to make a big capital purchase and therefore doesn't intend to pay it off immediately, it's important to consider the interest cost tradeoff with another kind of financing," Burton says. even though it takes extra effort to secure a loan from a bank or other lending institution, it often makes financial sense to do so, since the interest rate on credit cards is typically much higher than for such secured debt instruments, as mentioned earlier. It's also possible that a large purchase – or a couple of large expenditures – can max out your credit card and leave you without a source of funds at all.