Working capital required for growth can reduce your profits if you don’t plan ahead
Your customer base is expanding. You need to purchase more inventory or hire more staff, or both. You definitely need working capital.
The easiest, fastest way to access working capital is to use your credit card, if you have available credit. Nothing could be easier – but – it could prove to be a very costly method of financing the growth of your business.
When you look at your financial statements the following quarter, you may find that your profit margins have diminished because of an interest expense, and your credit score has dropped because you may have maxed out on your line of credit. At that point you do not have the credit to make additional purchases or continue with the additional payroll expense.
The path of progress is halted and now you have to seek options that can be both expensive and time consuming. You have taken the wrong path.
There are much better options than using credit cards for the growth of your business. . However, they require planning.
My advice is simple – Do not wait until you need funds to request working capital from lenders, Ask for funding before you need it.
A line of credit for a growing business is readily available from your bank if:
1. Your personal credit score is 680 or higher,
2. You can provide the bank the documentation they need to support the loan request, including tax returns for two years for the business and,
3. Your company’s profit and loss statement has adequate profits to support the loan request.
The cost of working capital from a bank will be substantially less than credit card debt, and, you will only pay for the dollars that you draw down for the period they are outstanding.
Credit cards, credit score and banks
You can repay the loan, or a portion of it, and draw the funds down again at any time as long as the amount does not exceed the limit of the working capital loan.
Some credit cards companies will provide an interest free period, but you have fewer options at the end of the free interest period. Your credit score may be lower, below 680 and the banks may no longer have an interest. Additionally banks do not like to repay third party debt, but they will require that the credit card debt is reduced when they consider a working capital loan. You cannot have it both ways.
Here is the rub.
So many accountants advise their clients to avoid income taxes by increasing shareholder distribution. This may leave the company with little or no residual net income at year end. There are inadequate funds available to service debt . Therefore the bank has no interest in providing funding for what may be a company ready for growth.
My advice to all entrepreneurs is, if you intend to seek a loan from a bank, show a profit. Discuss this with an advisor and your accountant.
Related content:
9 Steps to Access Capital for Your Growing Small Business
