I see many, many small businesses that use the business owners’ personal credit cards to finance their business. Although this is often an easy source of cash it can be a terrible way to manage and grow your small business.
Often the biggest issue we see is that the business owner doesn’t understand the relationship between the interest expense on the credit card debt as it relates to the net profits the business generates. We regularly see businesses where they are guaranteed to lose money on the sale of an item which the business owner set the price. Meaning the business owner thought he had priced the product to make a profit but in fact the price guaranteed a loss.
Here are some problems you might want to try to avoid. Here’s an example of what we see.
John owns a small sign business let’s call it SignCo. John started the business in his garage a few years ago and now he’s opened a shop in a small retail center. When John started the business he was a sole proprietor but last year he formed an LLC when he moved into his retail space. To get the retail space looking good John needed to buy some shelving, signs, cash register, chairs, etc. SignCo is too new and a bank won’t give the business a loan but John has personal credit cards and he puts his purchases on those cards. John has total of $20,000 on his credit cards and his interest rate is 18%.
John put together a budget for SignCo and he wants a 10% profit after operating expenses.
SignCo’s average sale is $100. How much does SignCo need to sell each month just to pay the interest on John’s credit card debts?
The answer $3,000 per month or 30 signs per month just to pay the interest on John’s credit cards. That’s $36,000 per year or 360 signs to pay the interest. It will take the sale of another $200,000 to pay the principal!
The math: $20,000 x 18% = $3,600/yer interest divided by 12 months = $300 per month @$10 profit per sign that’s 30 signs per month just to pay the interest.
The point is you need to understand the relationship between your profits and your debt costs before you make a decision to borrow money from anyone, including yourself.
Here are associated articles “How to Start a Business like you’ve Done it Before” and Business Owners and the Personal Guarantee
Finally, too many small business owners also fail to realize that personal credit card interest may not be tax deductible without some tricky accounting and documentation. If a business owner is running up his personal credit cards and then paying them off from his income from the business he is likely losing a substantial tax deduction, assuming he’s actually making a profit.
A very helpful book on managing small business finances:
Another article you may find useful:
Understanding the Inventory to Cash Cycle in Your Small Business