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April 30, 2020

How Should I Pay for That?

Most of us probably reach for our debit and credit cards automatically these days for payments. But is this the right thing to do? Choosing the right method of payment at the right time can mean a huge difference in the financial well-being of your company. 


Traditional wisdom tends to dictate that "cash is king"; only paying for something if you have the funds to do so on hand is a great way to prevent you from going underwater on your debt, which is expensive and can expose a business during hard times to difficult choices and consequences. This makes using your debit card the best option if you're good at managing your cash flow on a day-to-day basis; if you're using Formations or are good about checking your financials yourself daily you can sometimes feel your way through the process of paying your bills in a timely and less expensive manner yourself. This does come with drawbacks, however, and we'll discuss those as part of our deep dive into credit. 

A growing segment of this type of cash payment is online services like PayPal and Venmo. Both of these apps work as sort of a payment gateway that attaches to a method of payment (bank or credit card) to easily send money from the individual to the individual. While PayPal has a business service account that works much like a bank account and is easily trackable and categorized by us Venmo should be avoided as it does not provide us with any details of the transaction. If you pay your vendors with Venmo you will need to provide the vendor details and what it was for as we won't have access to that info. PayPal also has the added bonus of eliminating the need to issue a 1099 at the end of the year; since they are a verified payment processor they send the necessary documents to your vendors directly and to the IRS at the end of the year.  

If you do business with someone who still only accepts cash or checks then you need to get a W9 from them before you pay them as this is the only way you can properly issue a 1099 at the end of the year per IRS regulations. That and the uncertainty of when a check will be processed by your vendor can lead to some awkward cash flow shortages.  


There are quite a few credit vehicles that you can take advantage of as a business owner, the chief of which are credit cards, charge cards, lines of credit, and loans.  

Credit cards and charge cards are often the first and easiest form of credit for a company to obtain; many banks will allow corporate officers of S corps to use their personal credit to guarantee a business card as collateral, and some charge card companies (like American Express) will extend credit on a 30-day basis for many new businesses.  

We should examine the difference between each of these first: a credit card is issued by a lender or bank and generally allows you to carry a balance on the card from month to month, up to a limit, and usually has an annual fee and interest on the balance of the card if it carries over to a new month.

A charge card, on the other hand, functions much the same way at the point of sale but you cannot carry a balance month to month; the entire balance you accrue on it must be paid each month on a certain day and doesn't charge interest but also doesn't allow you to accrue a significant balance of the debt. 

So which is better? That's a subjective question; credit cards are easier to obtain and can help build good credit if managed correctly, but are generally much more expensive to have and can cause trouble if mismanaged or if business drops unexpectedly. Charge cards can offer higher limits but come with the obvious caveat of needing to pay it off every month or you won't be able to continue using it but they offer a great way to delay your expenses for at least a month. It will depend on your business's situation which to go with and is likely to be determined by your own credit score or that of your business.  

The more difficult to obtain but arguably far more useful forms of credit are loans and lines of credit. The reason these are more difficult to get is mostly due to the amounts that the lenders allow to be borrowed being so high, thus more collateral and good credit history are sought to approve them. Loans are fairly common in personal and business finances; they can be obtained from banks and lending houses but the amount of interest they carry depends a lot on the financial history of you and your business and the state of your assets, liabilities, and equity in the business. Lines of credit however are more like an extended credit card with much higher limits, but that higher limit also comes with the desire for collateral. The most common collateral is your personal residence, which is called a Home Equity Line of Credit (HELOC). Unlike a loan, a HELOC can be obtained, but not used until needed, so it's often a better solution for growing businesses just to hedge against a cash shortfall in the future. Be cautious with using either form of credit as it will usually need personal guarantees to execute from the bank. 

One type of credit that should absolutely be avoided at all costs is short-term, high-interest loans that require daily payments on the loan from the borrower and come with absurd interest (often as high as 20-30%). These are sort of like "payday" loans that have been criticized for being exploitative towards new and bad credit individuals by dangling a bridge loan that can keep the lights on for another month or two but the cost of which would negate any ability to leverage that amount to better your position in the market or fix the problem with the business that caused the need for the loan in the first place.  


Day to day and month to month the key here is to preserve your cash for when it's truly needed; such as paying vendors that don't take credit cards, payroll, and taxes. Otherwise, it's a good idea to try and move most of your regular expenses to a corporate credit or charge card that will make sure it's being paid, and then pay the balance of the statement every month to preserve good credit history and minimize/eliminate interest and fees. This keeps your income on hand 30 days longer than if you just paid for everything with your available cash, but it does come with rigid control of your spending to not outpace your income. You don't want to amass such a balance in a month that if your income drops unexpectedly you're unable to pay it off, but even if that happens it's good to have the ability to preserve your cash again and just pay a bit of interest for a while. 

We also recommend obtaining a line of credit as soon as you can just to hold it in reserve. Lines of credit come with more flexibility of repayment and your banker will often work with you to pay it down at a reasonable rate if you need to dip into it for a while during hard times. 

Loans should really be strategic and not "emergency" if it can be helped. You want to obtain a loan if you're planning on expanding your services and need equipment/advertising to help with that, or you want to expand into a new market. It's not free money (the opposite in fact; it will cost you far more than you lend even at reasonable interest rates) so you want to use it to MAKE more money than you're making now; if you're looking for a loan to "keep the lights on" then you'll want to do it in a way that you can turn it to a new revenue stream unless it's certain that keeping the company going for a while the same way will yield enough to pay the loan off. 


Let us know if you're seeking credit of any type; often we can provide the necessary statements and financials to your banker/lender to facilitate the credit process. Most will ask for financials for at least a year or two up to the current period (which if you're a Formations client should be just a call to your account manager away) or previous tax returns which we can send over at the drop of a hat. We also partner with a number of financial institutes and can recommend good lenders to confer with.

With any form of credit, it never hurts to talk to your advisor at Formations to understand your options and identify the best move for your business.