According to a recent survey, 30% of businesses fail, because the owner runs out of money.
How can you avoid this same fate?
You need access to financing, and securing a loan can be difficult. The same survey found that big banks approve 26.5% of small business loans, while smaller banks approve 50.2% of loan applications.
In addition, getting a bank loan is more involved than simply filling out paperwork.
Commercial lenders want to see a history of generating sales and profits, and you’ll need to provide collateral (accounts receivable balances, equipment) to secure repayment of the loan.
You may also need to personally guarantee repayment, which puts your personal assets (home, retirement plan accounts) at risk.
Using business credit cards, however, may be another option.
With proper planning and a disciplined approach, many owners finance their business operations using credit cards. Successful businesses can grow sales and profits, while minimizing the cost of using credit cards.
If you need access to credit and can’t get approved for a traditional bank loan, read on.
Assess your financing needs
To grow your business, you need financing, and many owners- particularly new business owners- have specific plans for growth.
The Kauffman Foundation’s 2018 survey of entrepreneurs reports that: “Some 78 percent of owners of startups younger than five years plan to offer a new product or service this year; 74 percent plan to raise their employees’ salaries and 55 percent plan to hire additional employees.”
To grow your company, the first step is to assess your financing needs, and to come up with a specific dollar amount needed to operate your business.
Here are some common business issues that impact your financing needs:
Where did your cash go?
Many business owners start the year with a sufficient cash balance, and find that they need financing as the year goes on. The most common reason for a cash shortage is a growing accounts receivable balance.
Your accounts receivable balance is money you’re owed by customers, and the balance can grow as you increase sales and don’t collect money fast enough. The good news is that you can ultimately collect the cash, and use the funds to repay a loan or credit card balance.
Take a look at your accounts receivable aging report, a document that lists your receivable balances based on each invoice date. The aging report will show the dollar amount of invoices that are 0 to 30 days old, 31 to 60 days, etc.
Use the aging report to calculate the dollar amount of receivables you expect to collect over the next few months. Collecting receivables reduces your overall financing need.
A retailer can’t sell a product if it’s not in inventory, and you need a plan to finance inventory purchases.
Many businesses don’t carefully plan for inventory purchases, and these firms risk the loss of a sale if inventory levels are too low. Every company should plan for an ending balance in inventory at month end, which allows the business to fill customer orders in the first few days of the next month.
So how do you plan?
For formula for ending inventory is: (beginning inventory + purchases – sales = ending inventory), and ending inventory is often based on a percentage of monthly sales. Use accounting software to create a customized report with this information.
Assume, for example, that a hardware store’s beginning inventory balance of lawn mowers is 50 units, and that the company forecasts 300 mower sales for the month. If the business wants 30 mowers (10% of expected sales) in ending inventory, the number of mowers purchased should be (300 projected sales + 30 ending inventory – 50 beginning inventory = 280 purchased).
Use an inventory formula report to ensure that you maintain a sufficient amount of inventory for each product that you sell. Once you know that dollar amount that you need to purchase, you can include that total in your financing assessment.
Replacing fixed assets
Many business owners don’t plan for the replacement of assets used in the business, and this mistake can have a huge impact on your company.
You can’t operate without fixed assets, and you need a plan to replace them over time. A pizza restaurant, for example, need ovens, refrigerators, furniture and other fixed assets to operate. Over time, these assets wear out, and must be replaced.
Where can you find this information?
Review your listing of fixed assets, which lists the remaining useful life of each asset. For example, if a $10,000 pizza oven has two years of useful life remaining, the owner must plan to pay cash, or take out a loan to replace the asset in two years.
Add the dollar amount of fixed assets you need to replace next year into your financing need assessment.
After finishing this analysis, you should know the dollar amount of receivables you expect to collect over the next few months, the inventory purchases required, and fixed assets that must be replaced in the next year few years.
Understanding liquidity and solvency
Business owners must understand the differences between short-term and long-term financing decisions, because credit card financing only addresses short-term issues.
Liquidity, for example, measures a firm’s ability to produce enough current assets to pay current liabilities, and this term has a short-term focus.
Current assets include cash, and other assets that will be converted into cash within 12 months. Accounts receivable and inventory balances, for example, will both be converted into cash within a year, and these are current asset accounts.
The current assets your business generates are used to pay off current liabilities, including accounts payable (bills you pay each month), payroll, and short-term loan balances, including credit card balances.
On the other hand, solvency refers to a company’s ability to generate enough profits to purchase assets and pay down long-term debt. So, your need to replace assets cannot be solved using credit cards.
Short-term financing should not be used to finance a need that your company faces over a period of years. Specifically, you shouldn’t use a credit card to purchase a $10,000 oven that will be used over the long term.
If you can’t get approved for a bank loan, you should set aside cash inflows to make the purchase down the road.
Use this information to match your financing needs with the right type of loan. Apply for credit cards to manage liquidity needs (accounts receivable and inventory), and use bank loans or a savings plan to address long-term financing issues.
Consider the pros and cons of credit cards
If you’ve considered your financing needs, and you decide that credit cards are an option for you, think about the pros and cons.
Using credit cards gives you several advantages. Credit cards are a form of revolving credit that allow you to borrow, pay off the balance, and borrow again. There’s no need to apply for new financing, once you’re approved for a credit card.
Credit cards don’t require you to put up collateral, and you can get access to financing without selling equity in your business. Over time, you can increase your available credit line and improve your business credit rating.
Technology makes it easy to track your spending, and your credit card statement activity can be integrated into your accounting software.
If you decide to use credit cards, you’ll also note some drawbacks.
The available credit you can access on a credit card is low, when compared to a bank loan, and you’ll pay higher interest rates. If you pay your balance late, you’ll incur penalties and fees, and that will damage your business credit rating.
Finally, if you use credit cards for both business and personal transactions, you must be careful to keep your business activity separated for tax reasons.
To successfully finance your business with credit cards, do your homework and stay on top of your card activity. You need a system to monitor your card balance, and to ensure that you pay your balance on the due date.
Make sure to understand each feature of your credit card. For example, you must track your card’s grace period, which is the number of days from the end of the billing cycle to the day your payment is due.
If you pay your balance in full and don’t have any cash advances outstanding, most credit cards won’t charge interest on new purchases made during the grace period.
Understand the pros and cons of credit cards, and put a system in place to monitor your spending and to make timely payments.
Meet Jill, who decides to use credit card financing
Jill owns Mountain View Furniture, a company that manufactures and sells customized wood furniture pieces. Mountain View’s profits have been inconsistent in recent years, and Jill does not have a solid profit history or sufficient collateral to secure a bank loan.
Mountain View’s primary financing issue is to fund monthly cash needs until receivables are collected. Jill collects receivables in 60 days, on average, and she needs about $20,000 available to cover payroll and to buy raw materials when receivables collections are delayed.
Jill also needs to replace a $30,000 piece of machinery in 18 months, and she is retaining some of her monthly profits to finance the purchase.
Mountain View gets approval for two business credit cards to cover the $20,000 financing need. Jill and her bookkeeper review the credit card terms together, and they build reminders into their accounting software for the monthly payment dates.
Jill and the bookkeeper also review the bank balance and expected cash inflows each week, and discuss the current credit card balances.
Mountain View’s financing plan allows the company to increase sales by 10%, and to finance raw materials for new projects. Jill is able to increase profits, and make timely payments on her credit card balances.
Action steps to take
To make smart financing decisions using credit cards, follow these steps:
Assess your financing needs, using the steps listed above. If you’re running short on cash and can’t get approval for a bank loan, look into a business credit card. Ask your accountant and other business owners for credit card companies that they recommend.
Put a formal cash collection procedure in place, so that you can reduce your accounts receivable balance. Use the aging schedule to email customers who have outstanding balances, and call customers for payment, if a receivable balance approaches 90 days old.
When you’re approved for a credit card
Carefully review the terms of the credit card agreement, including grace periods, interest rates, and payment due dates. Put systems in place that allow you to make payments on time.
Review your available cash balance, your expected cash inflow and outflows, and your credit card spending each week. If your cash collections increase, you may not need to use your credit card for a period of time. Monitor your activity and look for opportunities to avoid using your credit card.
Make each credit card payment on time, and set aside profits to pay for long-term financing needs.
Use this process to grow your business and increase profits. Over time, you can improve your firm’s creditworthiness and eventually replace credit card use with bank financing. You got this!