The hidden menace

Card yards: Credit is a popular financing option

Without credit cards, hundreds of thousands of small businesses would grind to a halt. Yet, apart from “reward” points, knowledge about credit cards among owners of those businesses rarely extends to the setting of interest rates on outstanding balances, or the trade-off between low rates and reward programs.

There is plenty of evidence that credit cards are greasing the wheels of Australian commerce.

Three in five small businesses admit turning to credit card financing, a 2009 survey by CPA Australia found.

It is a higher proportion than in Malaysia (55 per cent), Singapore (47 per cent) or Hong Kong (29 per cent). The level of dependence increases with size, with 80 per cent of businesses employing 10-19 people using credit cards, compared with 76 per cent of those employing five to nine, 63 per cent of those with one to four and 54 per cent of soloists.

Among the 100 businesses on this year’s BRW Fast Starters list, 15 cite credit cards as a “main” source of start-up capital – the second most popular after the founder’s own savings.

Business Switch managing director Matthew Abrahams confirms that nearly all of the start-ups approaching his Sydney advisory service for assistance are users of credit cards.

“There might be a handful of cases where people hate the credit card companies, or only want to pay in cash,” he says.

The popularity of credit cards is easily accounted for. First, most people already have a credit card for buying groceries and paying bills. If they use it one day to buy a computer and printer for a new venture, the card issuer, usually a bank, won’t bat an eyelid. But if a business owner asked the same bank for a business loan to pay for the computer and printer, they would almost certainly be knocked back.

Second, credit cards solve the riddle of small businesses having to spend money to make money. Nearly all banks refrain from charging interest on spending repaid by card holders by the due date on their monthly statements.

So purchases made at the end of the statement period are typically interest-free for 25 days, rising to up to 62 days for purchases made at the beginning. This is a “really good business asset” for small businesses whose clients do not pay them for 60 days from when they issue an invoice, Abrahams notes.

A third reason for the popularity of credit cards is the reward points. Owners who charge most business expenses to a card can soon earn enough points to fly the family to a holiday destination, or stock the cellar with a case or two of fine wine.

But beyond the “where could I go” or “what could I buy” sections of reward programs’ websites, the popularity of credit cards among small business owners is not matched by knowledge of how they work. As a result, experts warn, many small businesses are using the wrong cards, or using cards for the wrong purchases.

Credit cards with reward programs are inevitably coupled with high interest rates. The Reserve Bank of Australia says the average rate on a standard credit card with a reward program was 19.2 per cent at the end of April, compared with 13.2 per cent on the average low-rate card without reward points. For those who do not always pay off their monthly statements in full, this 6 percentage point gap in rates can easily chew up the value of those “free” reward flights to Fiji.

Worse, few owners realise that credit cards rates do not move in line with the RBA’s cash rate and home and business loan rates.

Ask banks what card rates are based on, says industry expert Mike Ebstein, of MWE Consulting, and they will usually cite the 90 day bank bill rate (an inter-bank lending rate that closely follows the RBA cash rate), plus a margin to account for the fact they are lending without any security in the event of a default.

But, in practice, Ebstein says, credit card rates move in a much narrower band than other rates. “It is more a case of matching the competition, as distinct from a precise science of funding costs plus a margin,” he explains.

Unfortunately for card holders, with the big four banks and their subsidiaries holding 70 per cent of outstanding balances at the end of March, competition between issuers is weak.

Between August 2008 and the end of April, the 90 day bank bill rate fell 2.76 per cent, home loans rates by 2.48 per cent and small business loan rates by 1.71 per cent. Standard credit card rates fell by just 0.75 per cent, while the average rate on a low-rate card went up over this period, by 0.25 per cent.

For this reason, Abrahams says, it is critical for owners, especially of businesses that are established and with a realistic shot at getting a business loan, to think carefully about whether a credit card is the right financing for particular purchases.

“Somebody who is using their credit card for an extended period of time, where they are paying 20 per cent-plus interest, they really should be seeking a business loan on more commercially acceptable terms,” he says.

Abrahams says the convenience of credit cards, in particular the ability to use them online, can lead owners into “impromptu and necessary” spending.

“There are some very strong business benefits to small businesses to using credit cards,” he says. “However, it is the way in which those cards are used that is going to determine whether they will serve the benefit of that business.”

BRW

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