Newsletter – Moneysaver by Accountant Mississauga

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<p><span style=”font-size: 16px;”><span style=”font-family: Arial;”><strong>The Perils of Credit Cards</strong></span></span></p>
<p class=”BMOpeningParagraph”><strong><span style=”font-size: 12px; font-family: Arial;”><span class=”BMDropCap”>Credit cards are very useful but they can also hurt you. </span></span></strong>
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<span style=”font-size: 12px; font-family: Arial;”>Do you know all the terms of all your credit cards? Do you really use or even want any of the benefits, such as rewards, travel or cash back for which you are eligible? Have you ever balanced the value of the benefits against the costs of using the card?
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Probably not.
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Credit card issuers have done their research and designed a range of cards for more finely identified market segments. The appeal to the consumer is in the various types of incentives: travel, rewards or cash back. The incentives vary but the common theme is a consumer benefit of some kind.
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Benefits can run from simple offerings such as:

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<li>Earn 2% cash back credits on grocery store purchases;</li>
<li>Earn up to 1% cash back credits on all other purchases;</li>
<li>Redeem your cash back credits on flexible terms; to the more complex:</li>
<li>Earn a welcome bonus of 150 AIR MILES®* reward miles on the first-time use of the card; </li>
<li>Earn one reward mile for every $15 in card purchases at AIR MILES®* Sponsors;</li>
<li>Earn one reward mile for every $20 in purchases charged anywhere else;</li>
<li>Shop at participating AIR MILES®* Sponsors across Canada with your BBBB® AIR MILES®* Credit Card and your AIR MILES®* Collector Card, and you can earn reward miles twice;</li>
<li>Redeem for a wide range of rewards — everything from movie tickets to electronics, travel and more.</li>
</ul>

<b>More Incentives Mean Higher Potential Cost</b><Br />
But how do the issuers give stuff away yet still make a profit? As a rule, if a credit card issuer offers more rewards, there is usually an annual fee and a higher interest rate on outstanding balances. Canadian business credit cards that offer annual rates as low as 3.25% – 4.50% offer little in the way of incentives. On the other hand, there are American-based credit card companies charging the equivalent of 30% annually on balances.
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<b>Convenience</b><br />
Credit card use has many advantages for both merchants and consumers. They protect merchants against NSF cheques since the card issuer deals with the consumer and the issuer’s quick payment to the merchant provides the merchant with virtually instant cash flow. Cards also provide a convenient loan for the user when cash is low and purchases are necessary. Combine these positives with the fact that credit card purchases effectively offer 20-30 days of interest-free bridge financing to the consumer (if the loan is repaid on time) and the usefulness of credit cards becomes obvious.
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<span style=”font-size: 12px; font-family: Arial;”>
<strong><i style=”border-bottom: 1px solid rgb(239, 72, 24); border-top: 1px solid rgb(239, 72, 24);”>Review your business credit cards and add up all the debt.</i></strong></span>
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<b>Credit Cards Can Be a Burden</b><br />
Why then have credit cards become such a burden not only to the economy of Canada, but also to the average Canadian? The answer is simple: the convenience of credit cards, combined with the rewards and the low minimum monthly payments, is difficult for the consumer to resist. However, as many consumers are discovering, it’s easier to run up balances than pay them down.
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So, how does the average small business owner control credit card debt?<Br />
The first step is to review the number of credit cards your business uses and add up the debt on each card. Most businesses will be surprised to discover that, although individual card debt is not great, the aggregate is significant.
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Review all your credit card statements for each of the last three months and ask yourself:
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<ul style=”list-style-type: square; padding-left: 40px;”>
<li>Were the cards used for purchases or to obtain cash advances? (Cash advances usually bear the highest interest rate and are calculated from the time of the withdrawal.)</li><br />
<li>Was interest paid on any card in the three months?</li><br />
<li>Were the cards paid off in full each month or were just the minimum payments made? How long will it take to pay off a balance if only the minimum payment continues to be made? This number can be a frightening reminder of the high cost of this kind of borrowing.</li>
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For example, assume a purchase of $2,500 and a minimum payment requirement for the month of 2% or $50 consisting of $37.50 in interest at 18% per annum and $12.50 in repaid principal. After the first payment, you will still owe $2,487.50. The following formula can be used as a rough calculation of how the principal and interest are calculated.
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1. Multiply $2,500 by 18% to get $450, the annualized amount of interest. <Br />
2. Divide $450 by 12 to get $37.50, the monthly amount of interest owed. <br />
3. Subtract $37.50 from $50 to get $12.50, the amount of principal repayable.<br /><br />
If the minimum-repayment requirement was 2% of the balance due every month, it will take approximately 334 months (just under 28 years) to pay off the $2,500. Interest costs alone will be $5,896.52 for a $2,500 piece of equipment!*
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*The above simplified example is given only to illustrate the perils of credit card financing by showing the typical consequences of failing to pay off the full balance by the due date. Because financial institutions differ in their methods of calculation, figures calculated in other ways may vary from those presented. The difference has to do with how the interest is calculated. Some institutions, for example, will calculate the interest on the first-of-month balance and some use the end-of-month balance. It could also be possible that the 18% is compounded daily.
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<li>What are the interest rates charged on the various cards?</li><br />
<li>What rewards have accumulated on the various cards in terms of cash back, travel points, etc.? Determine whether the rewards have accumulated sufficiently for you to take advantage of them.</li><br />
<li>Have the original “teaser rates” and free membership offers expired and are double digit rates and full membership costs now in effect?</li>
</ul>

Once you have calculated the reality of your current costs and rewards, eliminate those cards with the highest interest rates and the most incentives. Get a line of credit from your financial institution and pay off the credit cards with the highest balances and the highest interest rates. Then pay off the line of credit as quickly as possible. Structure a repayment schedule for the line of credit and stick to it. But be careful not to get caught in a second minimum-monthly-payment trap created to tempt you by some financial institutions.
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<b>Taking Control of Your Credit Card Use</b><br /><Br />
1. Cancel the credit cards that have been paid off.<br />
2. Learn to say NO to all credit card solicitation. Don’t be flattered when someone tells you that you have just been preapproved for a credit card with a $50,000 credit limit. <br />
3. Use only the credit cards that provide few benefits; they probably have a lower interest rate. If you want reward incentives, ensure the rewards earned exceed the cost of the yearly “membership” fee and that the rewards actually benefit you and your business. <br />
4. Pay off the full balance every month. This allows rewards to accumulate but not the interest that will negate the value of the rewards. <br />
5. Put low credit limits on the cards. This will restrict card use and make paying the monthly balance easier.<br /><br />

<b>The Obvious Benefits</b><Br />
It is certainly a good idea to have more than one credit card (i.e., a “spare” for emergencies or in case your primary card is compromised) but use the additional card only as a backup. Use cash or a debit card to fill up the gas tank and make other everyday purchases.
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Credit cards are part of our business reality. They make transacting business much easier, provide access to emergency funds, permit tracking and accounting for expenditures and provide 20-30 days of free financing for your business. However, letting credit card balances get out of control can quickly affect cash flow requirements and the bottom line. Use them wisely.

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<h3>April 2013</h3>
<p><strong>This issue’s topics deal with:</strong></p>
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<li><a href=”../../../../newsletter/newsletter-management”>What Should I Charge for My
Services?</a></li>
<li><a href=”../../../../newsletter/newsletter-technology”>Online Purchasing</a></li>
<li><a href=”../../../../newsletter/newsletter-moneysaver”>The Perils of Credit Cards</a></li>
<li><a href=”../../../../newsletter/newsletter-taxation”>Tax Tips for 2013</a></li>
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