Why credit cards can be a bad idea

Nick Hood, the senior London partner of Begbies Traynor, the AIM-listed business rescue firm, looks at the perils of mixing business and pleasure when it comes to paying the bills.

I suspect many others, also involved with business finance, winced just as I did when reading Warwick Business School’s recent research which revealed that owners of small and medium-sized enterprises in the UK are spending an astonishing £1.8 billion a month on their personal credit cards to help fund their ventures. And it’s not just travel and entertainment which SME bosses are putting on their personal credit cards. Business costs of all types, including major items such as vehicles and equipment, are being charged to these cards.

The reasons for this aren’t hard to fathom. Dealing with business expenditure is so easy this way. With the credit card companies making credit so freely available, getting a sizeable limit on a selection of cards is simple. Most of the adult population is being bombarded with offers of new cards in unsolicited mail shots, and from just about every other imaginable media source. With such plentiful credit on offer, in no time you can have up to £50,000 of credit at your disposal, across just a few cards.

The chances are that a large slice of that £1.8 billion was spent by relatively new companies. Many of them will have been startups, still trying to establish a track record and get decent credit terms from their suppliers and service providers, never mind funding from banks.

We all know how difficult it is for startups to get finance from traditional sources like banks or factoring companies. A year’s trading and audited accounts showing a decent level of profitability are usually a pre-requisite for accessing these types of funding. Curiously, it’s often easier to get backing from banks before starting to trade at all. Of course in this case there’s the grind of writing a business plan and then selling your business concept to a hard-nosed bank manager, who will no doubt ask you for a personal guarantee and possibly a charge over your property to back it up.

But we should all stand back and ask ourselves why getting an overdraft or a loan from a bank is difficult. The answer’s simple – banks like to assess risk and lend properly, so they need to put businesses through the financial wringer before they let people loose with their money. It may be irritating, but a sensible professional evaluation of a startup business can bring huge benefits, identifying issues the owner hasn’t thought through and asking those awkward “but what if” questions.

And if the banks want to lend responsibly, look at it from your own point of view: why would you want to borrow irresponsibly? Because that’s exactly what using your personal credit card can be. The interest charges are much higher than at the bank. Keeping control of your levels of debt is more difficult, because extending the credit limit is usually fairly straightforward. And separating business and personal expenses can be a much more arduous process, making sorting out the accounting unnecessarily difficult.

My advice is not to substitute convenience for recklessness. If you do use a card for business purposes, budget in your cash flow for repaying the bill in full each month. This is the only reliable way of avoiding future financial trouble.

And if you’re faced with the temptation to use your plastic to fund the costs for that great order you have been offered just when you’re bumping up against your overdraft limit, ask yourself how long it will be before the customer pays you and factor in the extra interest costs. Then ask yourself if it’s still worth it, and acknowledge that paying on your personal credit card will be a risk. If you decide to go ahead, be sensible and check out the creditworthiness of the customer particularly carefully: if they don’t pay, the chances are you’ll never be able to take the money back out of your business to repay your credit card debt.

If it’s impossible for the time being to break the credit card habit, be wise and regularly review your cards. Take advantage of offers for interest-free periods and reduced APRs that still abound in this highly-competitive sector. But be very careful, because holders who change cards too frequently are at risk of getting a poor credit rating, which makes borrowing more difficult. Enquire if your existing card issuer is prepared to offer better terms for loyalty. These deals are not widely advertised, so you may have to be fairly direct in asking for one.

If, unfortunately, you have run up large debts on a variety of cards on behalf of your business and you are paying crippling interest charges, get advice immediately. It’s better to consolidate your debts with a single lender, paying what will almost certainly be a lower rate of interest. But please keep very well away from the loan sharks still lurking in the depths of the credit pool.

So if you can avoid it, don’t use your plastic heavily for business. Concentrate on raising enough finance at the outset through a bank and by injecting enough initial capital into the enterprise. And if you are a startup owner manager with stressed out credit cards, don’t delay in getting specialist advice and dealing with the problem right away. Doing this is a very positive move and will immediately put your business on a stronger footing. You know it makes sense!