This blog is written by John Rampton, and does not necessarily reflect the views of Western Union.
As any small business owner or entrepreneur will inform you, having an idea for a business will only take you so far. Even if it’s the most revolutionary idea since the invention of the wheel, your idea can fail if there isn’t a market or enough funding to make the idea into a reality.
In the past, business owners would often turn to investors, whether it was friends and family or VCs, bootstrap the business themselves, or secure a loan from a bank. Today, however, a small business owner can use crowdfunding, peer-to-peer lending sites, or online loan marketplaces.
Despite these changes, business credit cards and lines of credit remain a popular option for small business owners. But, the question still remains, which of these types of funding is better for your business?
Credit Cards vs Lines of Credit
While both a credit card and line of credit are essentially sources of credit issued by a bank or financial institution, there are several important differences between the two.
These differences include;
- Interest rate.
- Grace period and rewards offered.
- The fees involved.
- The limit amount provided.
- How much can be withdrawn as a cash advance.
- The type of customer who uses each.
With that in mind, here’s a closer look at the pros and cons between credit cards and lines of credit based on their main differences.
Most credit cards also offer grace periods so that you can postpone a payment within the grace period and not be hit with a late fee. Some cards also come with rewards for being a customer.
On the downside, credit cards have relatively high interest rates. These interest rates could end up costing your business a lot of money if you carry a balance.
Additionally, users might only be able to withdraw approximately 20% of their limit for cash advances and there are typically also fees involved for cash advances.
Lines of Credit
Lines of credit typically offer higher credit limits than credit cards. However, some companies require a verification of income. Some financial institutions will allow you to put a line of credit against the equity you have built on your home. These lines of credit mean that they are not as immediately accessible as credit cards. Another drawback regarding lines of credit is that there is not a grace period or offer rewards.
However, lines of credit typically have lower interest rates than credit cards, and 100% of a limit can be withdrawn as cash at no additional fee.
Finally, if you’re dealing with a vendor who doesn’t accept credit cards, then a line of credit could provide you with the money to take care of that payment.
Choosing a Business Credit Card
If you decide to apply for a business credit card, NerdWallet has provided five simple steps to follow to make the process less overwhelming.
The first step is understanding credit card basics. This means that you should only use the card for business expenses, pay your bill on time, and be aware that business credit cards come with higher limits than personal cards. You can also issue cards to employees, so that you have the ability to keep tabs on their spending, as well.
You also want to review your own expenditures so that you can find the card that offers the best rewards for your business. For example, as Lindsay Konsko, points out in NerdWallet, “if your business involves providing a lot of customer support over the phone, you’re probably spending a lot each month on wireless phone service.”
You may want to consider your company’s "lifestyle" when examining the reward offered. For example, if you and your employees do a lot of traveling or entertain customers by taking them out to dinner, then you should be on the lookout for cards that provide redeemable rewards for flights, hotels, gas, or restaurant spending.
Don’t forget to look at the fringe benefits, such as an introductory 0% APR.
Finally, weigh the pros and cons of paying an annual fee. As Konsko says, “Consider your business’s annual spending and the rewards rates of the cards you’re considering. It’s a good way to open up more card options, or alternatively, eliminate a few.”
The Basics of Lines of Credit
If you’re still not exactly sure what a line of credit is and how it works, Stephen D. Simpson, CFA, provides a clean explanation on Investopedia.
“A line of credit is basically a flexible loan from a bank or financial institution to an individual or business,” writes Simpson. “Not unlike how a credit card offers you a limited amount of funds that you can use when, if, and how you wish, a line of credit is a limited/specified amount of money that an individual can access as needed and then repay immediately or over a pre-specified period of time.”
Simpson adds that lines of credit are useful because they address “the fact that banks are not terribly interested in underwriting one-time personal loans, particularly unsecured loans, for most customers,”.
Lines of credit are not intended to make large purchases, such as buying a new office building. Lines of credit are intended, however, when you require quick instant access to cash on an "as-needed" basis. This type of needed loan could include paying taxes, rent, or other expenses. In other words, lines of credit could provide cash flow when your business needs it at a reasonable interest rate.
Final Verdict: Lines or credit or credit cards?
There are pros and cons to both lines of credit or credit cards. As a business owner, it’s up to you to do your due diligence and weigh the options before committing to either.
In general, credit cards are probably a better option if you make frequent purchases each month and you are able to pay off your balance.
If you need a cash advance, to pay your quarterly taxes, then a line of credit would be better suited for your needs. This may be especially true for the self-employed, freelancers, or businesses who rely on commissions and have an uneven income.
Have you used credit cards or lines of credit for your business? Which one did you prefer?
John Rampton is an entrepreneur, investor, online marketing guru and startup enthusiast. He is founder of the online invoicing company Due. John is best known as an entrepreneur and connector. He was recently named #2 on Top 50 Online Influencers in the World by Entrepreneur Magazine and a blogging expert by Time. He currently advises several companies in the San Francisco Bay area.