When your business needs cash, you have dozens of options for finding funding. You might apply for a small-business loan or use invoice factoring; you could try a trendy funding method like crowdsourcing or microloans; or you could rely on your business’s credit to get you the cash you need. Yet, with that last option, there is one important question: credit card or line of credit?
Most business blogs explain lines of credit with analogies to personal credit cards, but the truth is lines of credit work differently than your average plastic form of payment. You must understand the differences ― including the types, the purposes, and the methods of acquisition ― to keep your business financially healthy for years to come.
Business Credit Cards
A business credit card is almost identical to a personal credit card. Both are actual pieces of plastic with numbers, chips, and signatures; both grant access to an amount of credit determined by your lender; and both are exceedingly easy to abuse. Credit cards have almost no restrictions on their use, which means you can use your business credit card to make essential business purchases ― like office supplies and equipment ― or to buy your lunch every day. Most business owners see this freedom as beneficial, but if you aren’t careful with your spending, you can fall into serious credit card debt quickly and run your business and personal finances into the ground.
In fact, business credit cards are even more dangerous than personal cards for a handful of reasons. Businesses aren’t covered by the same protections that keep consumer credit users safe. The Credit CARD Act of 2009 applies expressly to consumers; some lenders extend the protections to business credit cards, but they certainly don’t have to. Additionally, business credit limits tend to be higher, giving you more opportunity to spend way beyond your means. Worst of all, because the line between personal and business funds is blurry amongst small business owners, your business credit debt will likely affect your personal credit history for life.
Still, there are advantages to having a business credit card. Perhaps the most basic benefit is it allows small-business owners to efficiently separate business and personal expenses. In addition, business credit cards often boast lower interest rates and better rewards, including points and miles. Plus, almost anyone who earns money outside of typical employment can qualify for a business credit card, which means freelancers have access to this useful business funding. Overall, business credit cards are flexible and functional ― if somewhat daunting for first-time business owners.
Lines of Credit
Conversely, business lines of credit offer less flexibility but more funding for certain critical business activities. A business line of credit gives you access to a maximum balance which you can draw down at any time to make specific payments, like a loan, but you only pay interest on the money you use, and you can arrange the line of credit to be recurring, like a credit card. Though lines of credit lack some of the flashy perks of credit cards ― such as reward programs, cash back, and no-API grace periods ― they tend to provide more reliable funding. For example, you can take 100 percent of your line of credit balance in a cash advance, and most lines of credit claim no hidden fees, whereas credit cards often do.
Lenders typically offer lines of credit for one of four business purposes:
- Working capital. When your cash is tied up in your accounts receivable, your working capital line of credit can keep the lights on and your employees paid. Usually, working capital lines are one-year terms, renewable annually, with floating rates.
- Asset purchase. This non-revolving line gives you money to buy equipment, property, or other assets vital to your business. A lender will provide a majority of the purchase’s costs upfront, and once the balance is used up, you cannot take any more advances until the loan is paid.
- Construction. To use a construction line of credit, you must first fund your project out-of-pocket. Then the lender inspects the property and reimburses you. Like asset purchase lines, construction lines are non-revolving.
- Guidance. Boasting the highest balances but the most restricted use, guidance lines are best for businesses that might need large amounts of cash especially quickly, like a real estate company snatching up property. Every withdrawal requires approval, but the line can be renewed annually if the lending relationship is good.
While credit cards may assist with small purchases, lines of credit are invaluable tools for businesses with stuttered cash flow or big plans for growth ― which is to say most small businesses. Before you make a credit decision for your business, it is important to know what you need now and what you will need in the future to keep you and your business financially safe and secure.
Categories: Credit Cards