Using Credit Cards for your Small Business Financing

Using Credit Cards for your Small Business Financing

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

Build a Business that Can be Sold –  What makes a business valuable to a buyer?

Article Library – Buying , Selling and Running a Business

Can Owning a Small Business Make You Wealthy?

What’s the Value of This Business? Here’s a little game, takes 2 minutes

The best business planning tool?

If you plan to be in business you’d better have a Business Plan. If you plan to start a small business this tool can be the difference between success and losing everything. If you think this Business Plan tool is expensive wait til you see how expensive it is to NOT have a well thought out and written business plan.

If you are considering starting or buying a business it’s a good idea to have the best tools. It may cost you a few bucks but it could be a cost that saves you many, many thousands of dollars.

A good business planning tool will also allow you to compare options from a consistent platform.

I think the best Business Plan Software on the market today is Business Plan Pro . (Yes, this is an affiliate link and we get a few cents if you buy it but, hey, give us a break, we did the research).

The best part about this software is it’s intuitive and you don’t need an MBA to operate it. The Standard edition is all most people ever need. It’s a product that has been around for many years and it’s very practical and efficient to learn.

As you can see the layouts are clean and easy to understand.

Let the software do the math
If you are going to get into business you need a plan that is logical, well thought out and proven. Trust me, if you go to your banker with a professional business plan your odds of getting financing improve dramatically. A plan like the one Business Plan Pro produces will be a requirement for any SBA loans that you apply for or pursue.

Here’s a few fatal mistakes a good business plan can help you avoid.

The best time to have a business plan is before someone asks you to see it! Get ahead of the curve…get your plan.

Circular Money and the U.S. Tax System

Listening to a financial radio station today I heard something that caused me to say…”what?” Here’s the outline:

First the Cash Source:
China has gobs of U.S. dollars that they get from selling us incredible amounts of stuff.
China is catching heat for owning so much U.S. Treasury debt, so they want to use the US Dollars for something other than lending it back to the US Treasury. So why not loan it to U.S. companies?

The Use of Cash:
A big U.S. company, that will remain nameless, pays 1.8% dividend on it’s stock. Note, this is important …Dividends for biz are not tax deductible, meaning companies pay dividends after they pay their tax obligations.

So what to do?
This company borrows US Dollars at 1.7% interest from China. The 1.7% interest is tax deductible which means the effective cost of the interest is about 1.2%…and remember the effective cost of dividends is 1.8% because dividends are not tax deductible. So the cost to the company for borrowing from China is 33% cheaper than the dividend cost.

The solution, borrow US Dollars from China, deduct the interest from taxes and use the cash to buy back the stock which eliminates the 1.8% cash dividend cost and replaces if with an effective $1.2% cash cost.

Incredible but true, another case of the perverted U.S. tax code. Borrowing is more tax effective than returning cash to shareholders as dividends.

What is Working Capital and why is it Important?

Many small business owners don’t understand or appreciate the need to have a good handle on working capital and how it is generated or consumed by the business. Let’s take 2 examples on opposite ends of the business spectrum.

First a Day Spa. At a day spa the customer comes in, pays for the services and then gets the services – no accounts receivables to collect…no money, no service. Also, a Day Spa sell lots and lots of Gift Certificates. With gift certificates the biz collects $100 for a gift certificate and has the cash for weeks, months, years or even forever before the service is delivered. That’s called negative working capital. I get your money before I incur the cost of providing the service.

Now lets look at an office supply business. A customer calls up, orders 5 cases of paper for delivery at a cost of $200 and the customer wants you to “bill” them. Which means they will pay in about 30 days. This $200 order requires a lot of working capital…you had to buy the paper, pay the driver, pay the person who took the order all BEFORE the customer pays you the $200. All those expenses you had to pay out before the customer paid you needs working capital to pay.

That’s why understanding working capital is critical, if you are in a business that needs working capital to grow you’d better figure out where the working capital is coming from before you start to grow. Many. many profitable businesses have gone out of business because they didn’t account for, and plan for, the working capital needs of the business.

New Tax Law is ready to go but…………………..

The new tax law extending current tax rates and spending a couple of hundred $$Billion$$ more is headed for the president’s desk.

However, FYI – the bill does not rescind the obligation for businesses issuing 1099s that was passed in the Obama care bill. Soooo…………. unless something changes look for small businesses being burdened with many 1000s of 1099s to be issued. I saw an IRS estimate that they would get over 1 BILLION more 1099s under the new law!  By example, for my business I’ll need to go from about 15 issued 1099s now to about 300 required under the new law. Geeeezzz…………………………

The Bush tax cuts debate and the real small business story

It’s hard to avoid the politicians ranting either for or against the extension of the Bush tax cuts. Like many issues in life, for every complex problem there is a simple solution that is absolutely wrong.

Those opposed to the extension often try to separate the issue of “who” gets the extension. The theory is the high income earners should not get the extension and therefore pay more in taxes because they can afford it.

Those in favor of extensions for everyone say if the extension of the cuts isn’t done it will cost jobs and be a drag on the economy.

In this case the unfortunate truth is they may both be right. So if they are both right how do we decide which policy is best.

Let’s take the case of Mary who owns a pest control business. Like many small business owners her income can vary wildly from year-to-year. For the sake of this discussion let’s say that she and her husband, who also works in the business, make $300,000 combined. Since many politicians have said that the tax cuts should not be extended for those who make over $250,000 let’s use that as income above which the Bush tax cuts expire.

So let’s go with that, Mary and Bob currently make $300,000 per year and, if the Bush tax cuts are eliminated, they are going to get a 10% tax increase on income over $250,000. I’ll use round numbers again..their new tax rate goes to 40% from today’s current 36%.

Now Mary and Bob have a good idea. They think they can grow their business next year and increase their income by $50,000 to $350,000 but they will need to hire someone for $32,000 a year to do the job. Seems like a good idea right? Spend $32,000 and make an extra $50,000..easy decision. Well, maybe not. Here’s the math if the Bush tax cuts expire for her:

  1. Mary pays an employee $32,000.
  2. Mary makes additional $50,000 before tax and $30,000 after taxes (40% tax rate)
  3. Mary pays additional tax of 3.6% (difference between old rate and new) on the $50,000 she already makes above the $250,000 tax increase line. That’s another $1,800 in taxes

So what happened here? Mary made $50,000 more and has $3,600 less in cold hard cash. (The math is $50,000 – $32,000- $20,000 – $1,600 = -$3,600)

What would you do? Take the risk of hiring someone for $32,000 so you can lose $3,600?

The same situation if the tax rate for Mary is extended:

  1. Mary hires and pays an employee $32,000
  2. Mary makes additional $50,000 before tax and $32,000 after taxes (36% current tax rate)
In this case if her plan works Mary is break-even. Remember from above, if the tax increase goes into effect Mary will lose $3,600 if her plan works perfectly. Without increasing her taxes she’s break-even.
What’s the difference? If the tax increase goes into effect and Mary decides not to hire the new employee
 the tax effect to Mary is $1,600 and the new employee doesn’t have a job.
If the tax increase doesn’t go into effect what happens? Mary hires the new employee, Mary pays $18,000 MORE in taxes because she made $50,000 more taxed at old rate AND the IRS gets to tax the new employee on his $32,000 salary. Mary makes more money, another person has a job and IRS gets more money. But Mary had to be willing to take the risk! None of this happens unless Mary takes the risk. It’s not the government taking the risk, it’s Mary that has to take the risk. 
There are millions of people like Mary and Bob in the U.S. today making these same decisions every day.
The point of this is that nearly all financial decisions are made at the margin not based on the overall. Mary didn’t make her decision based on the $300,000 she makes, she made the decision based on the next $50,000 she might make.