Small business startup costs

Credit cards as small business funding sources

Do you need financing to help your business get through a shortfall of cash, or purchase inventory or fixed assets? Debt financing is one option.

Debt financing is money loaned to you or your business, usually by a commercial bank or credit union, for which the lender has a right to earn interest.

Here’s one example of debt financing: using a corporate credit card as a financing solution in your small business.

Pros and cons of corporate credit cards as small business financing

One pro of using a corporate credit card as small business financing is that they offer the convenience of a line of credit. The credit is there when you need it, and it allows you to keep personal and business purchases separate from each other.

However, there’s a downside too. Business credit cards have higher interest rates. And if your business fails, you’ll most likely be the one responsible for full repayment of any outstanding credit card balance. So make sure you read and understand the terms fully before you commit.

A note about credit limits

How do credit limits factor into small business financing? Here’s an example. You have a personal credit card with an unused credit limit of $20,000, and you want to get a business loan from the bank. However, you might discover that this unused credit will be considered debt that you’ve already incurred. This will increase your debt to equity ratio, which banks use to figure out the current proportion of debt you have compared to your equity. Their logic here is that you haven’t used that $20,000 of available credit, but there’s the potential that you could.

The importance of credit rating

As with anything credit card-related, it’s important to be aware and stay on top of things, particularly your credit rating. Make sure to cancel credit cards you don’t need anymore, to reduce the revolving credit debt that the banks see when they review your credit history. A better credit rating means better interest rates and better loan terms. Win-win!

Check out Equifax Canada or TransUnion Canada to find out your personal credit score. Review this report with a fine-toothed comb, keeping an eye out for credit cards you may have cancelled but which still show up on your credit report (these affect your debt to equity ratio). Errors may exist too, including loans you don’t have, employers you no longer work for, information that isn’t yours, and more.

Check your credit report annually, and well in advance of applying for a loan, corporate credit card, or mortgage. Notify the credit company of any mistakes so enough time will elapse for the correction to be made. This way, your credit score will be as good as it can be when you meet with the bank.

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Using a line of credit to finance a small business

small-business-debt-financingDebt financing is money loaned to you or your business, for which the lender has a right to earn interest. Many small business turn to debt financing through commercial banks and credit unions. These institutions will lend a portion of the value of your business’ fixed assets. You can then use this financing to buy inventory or additional fixed assets, or to help your business through a cash shortfall.

Today, let’s look at the line of credit to finance your small business’ needs.

What is a line of credit?

A line of credit is a loan used by the borrower when needed and is usually secured by an asset. For example, a home equity line of credit (HELOC) is secured by the equity in the borrower’s home. A commercial line of credit (CLOC) is a business line of credit secured by company assets like inventory or equipment.

Lenders will usually advance between 50–80% of the value of your accounts receivable plus 50% of the value of inventory — known as a margin formula. There is an agreement between the borrower and the lender on the amount of line of credit, interest rate, and terms of repayment.

Why use a line of credit for small business financing?

Many small business owners turn to lines of credit because they’re convenient. They can be used in emergencies without having to go to the lender to ask for a new loan.

One word of warning: always arrange for a line of credit before you actually need it. Trying to get a loan when you’re already in a cash flow crisis is usually a dead end.

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Debt sources of financing for small business

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Debt sources of financing for small businesses

small-business-sources-of-financingNeed some financing to help you start or grow your small business? Start here. Some novice entrepreneurs assume that their good credit rating, great relationship with their bank or banker, or previous car or mortgage loans means getting a loan for a new business should be simple. However, it’s not quite that easy.

New businesses don’t have a track record of success, most new businesses fail, and banks don’t like to take risks. This means getting a business loan is a lot tougher than you might think.

That said, with the right preparation and planning you might qualify for debt financing, depending on your personal equity and that of your business. There are four common lending methods that small business owners can pursue through chartered and commercial banks and credit unions.

  1. Line of creditA convenient type of loan used by you only when you need it, and usually secured by an asset.
  2. Term loansLoans repayable over several different time periods. Demand Loans are payable upon demand; Instalment Loans are payable in equal monthly instalments; and Time Loans are payable at some time to be determined in the future, or at maturity.
  3. MortgagesLoans given with your personal property or real estate as collateral until repayment.
  4. Corporate credit cards

To help your chances when pursuing a loan, it’s important to understand the lender’s perspective. Generally, loans are given based on a review of your five Cs of credit:

  1. Your character
  2. Your capacity to repay the loan
  3. The capital being invested by you in your business
  4. The amount of collateral available to secure your loan
  5. The conditions of the industry and economy

Obviously with a new small business owner, the first two — character and capacity — become the most important evaluation elements. This is because your new business’ financial estimates are based on forecasts, so the lender will likely consider your personal financial history very closely.

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