Cash is king and a bank account full of cash feels good. But what happens when your cash dries up? Do you reach for the company credit card to cover everyday business expenses?
Although a credit card is the convenient solution for a cash shortfall, it also has downsides to watch out for, including getting locked into a frustrating debt trap.
One way you can find yourself neck-deep in credit card debt is via credit card floats. Here’s everything you need to know about credit card floats, plus how to avoid them.
What is a credit card float in finance?
Credit card float has two meanings.
- Living on credit card debt: When you’re charging everyday expenses on your credit card and hoping for future income to pay off the previous purchases. This is usually done out of necessity when cash flow is slow.
- Capitalizing on interest-free lag time: Similar to the OPM (Other People’s Money) idea in finance. Instead of paying for purchases with cash, you pay with a credit card and invest your money during the interest-free period before the credit card payment is due. It’s like taking advantage of a short and convenient interest-free line of credit. This is more of a strategic financial decision because you have the cash to pay for the purchases but choose to invest it during the interest-free period to earn a return.
Too much reliance on a credit card float can be risky. You’ll owe interest to the credit card company if you don’t pay your balance in full on the due date.
Example of a credit card float as debt
Let’s say you have a supplier’s invoice of $40,000, which you need to pay by June 25. The problem is that you only have $30,000 in your bank account and expect to have less than $40,000 by June 25.
You have a corporate credit card with a $50,000 credit limit, and your credit card payment is due on July 10. And you expect to collect $75,000 in cash from monthly customers’ subscription fees on July 1.
So this is what you can do.
You’ll use your credit card to pay the supplier’s bill of $40,000 on June 25, even though you only have $30,000 in the bank. Using a credit card may make sense because the bill on your credit card will be due later on July 10.
By then, you’ll receive the $75,000 monthly subscriptions and have enough money in your bank account to pay the $40,000 credit card bill in full.
Example of a credit card float as an interest-free line of credit
A profitable handbag business purchases $100,000 in leather on September 1 to create its handbags. Although the company has $100,000 in cash in the bank, it charges this amount on a company credit card, which is due on October 2.
The company keeps its $100,000 cash in a high-yield savings account, which earns $300 in interest from September 1 to October 2.
And on October 2, the company pays the credit card account in full with the cash in the savings account and doesn’t pay interest to the credit card company.
In the meantime, the company earned $300 in interest by successfully using a strategic credit card float. It may have come out even further ahead if the credit card offered a cashback or rewards program.
How does a credit card float happen?
Generally, a credit card float happens when you don't have enough cash to pay for expenses and wind up making purchases on your credit card instead. You end up "floating" your expenses on the credit card until payment is due.
But a credit card float can also be a strategic decision not born out of necessity. In these situations, you have cash to pay for expenses but elect to invest it instead of using it right away to pay for your expenses.
Cons of allowing a credit card float
Although a credit card float can come in handy in an emergency or earn you some extra cash, it comes with risks you should know.
Risks financial instability
A credit card float can destabilize finances. Let’s say you use a float, which comes to a substantial sum, hoping you’ll get cash before the credit card due date. Unfortunately, the expected cash doesn’t materialize.
When this happens to a business, it can cause considerable immediate and long-term financial instability. The company might be tempted to divert cash earmarked for operations to pay off the credit card float.
But the consequence of diverting cash meant for operations can be crippling. Remember, you’ll still need to pay salaries and utilities, and buy inventory. And you may end up in a cycle of debt, which we discuss next.
Anything that can destabilize your cash flow, including a credit card float, should be handled with extreme care and caution.
Creates a cycle of debt
Another downside of a credit card float is its potential to trap you in debt. You may find yourself using all business income to pay off or reduce outstanding debt, leaving nothing for business growth and development.
Plus, credit card debt can have interest rates that are higher than those of other loan types. This erodes profits, further limiting one's ability to expand and improve.
Potential for increased spending
Even with a budget, credit card float can cause increased spending. Knowing you can spend more than you have in the bank can tempt you to spend more than you need to.
And it is not just buying more things.
Credit card users are likely to buy stuff at a higher price. Behavioral psychologists have long studied the behavior that leads to people’s willingness to pay higher prices when charging a purchase instead of paying cash.
If you have cash in your wallet, it’s something you can see and touch. When you buy something with cash, you give the cash away. But with credit cards, purchases are merely numbers on a screen or piece of paper. The actual cost from your viewpoint is only realized when the credit card bill is received much later.
Impacts credit utilization
Credit utilization refers to the proportion of a cardholder’s available credit currently used.
If you have a credit card with a $50,000 limit and a $25,000 balance, your credit utilization is 50% ($25,000 ÷ $50,000).
Although there should be nothing wrong with maxing out your credit limit if you can pay it without incurring interest, this is often not the case. A high credit utilization can lower your credit score.
Securing future financing becomes difficult with a high credit utilization rate. Lenders see this as a sign of financial stress and may be reluctant to offer favorable terms. Which means you’ll pay higher interest rates.
Interest and fees risk
Managing unsustainable debt levels isn’t the only downside of a credit card float.
Credit cards aren’t interest-free. Failing to pay your balance in full means you’re stuck paying interest on the current unpaid portion and on the next month’s purchases. With credit card interest rates nearing 25%, interest expenses can quickly pile up, leaving you with less cash for growth or investments.
Should you “Ride the Float”?
To ride the credit float — to use credit to cover the cash you don’t have at the moment — should come with well-thought-out considerations.
On one side, holding onto cash until the end of a credit card’s float period technically means you have some cash reserves you can fall back on in an emergency.
But riding a credit card float can be risky. For example, what if you don’t have the cash to pay the credit card charges when your bill becomes due?
Or, you can find yourself in a position with enough cash to pay the credit card bill but not enough to cover your current month's operational expenses, leading to a frustrating cycle of debt.
To know if you should ride your credit card float, draw up conservative budget projections to make sure you have enough money to cover your bills and track your spending. If you're consistently spending more than you budgeted, there may be better choices than a credit card float.
Riding the float requires discipline and careful planning. Without those two, it’s best to avoid the risks of potential interest charges and debt accumulation.
Options to cover expenses without doing a credit card float
Fortunately, a credit card float is one of many ways to cover your business expenses. The following are other creative options you can explore without the back-and-forth hassles common with traditional bank lending.
Cash advance
One of the most common types of cash advance for ecommerce businesses is the merchant cash advance. In this type of loan, a lender gives a borrower a lump sum based on the borrower's historical sales. To hedge their bets, lenders typically receive repayment via a percentage of future credit card-based sales.
Invoice factoring
Invoice factoring involves selling unpaid customer invoices to a third party for immediate cash. These lenders typically give the borrower a percentage of the unpaid invoice value. The lender then collects the amounts on unpaid invoices directly from your customers.
Business loan
The standard type of business loan is a term loan, or a one-time lump sum advanced by a lender to a borrower that the borrower will repay with interest over a set period. The primary advantage of term loans is that they have lower interest rates compared to other forms of business financing.
Working capital
One of the major challenges entrepreneurs face is how to finance a business, especially the day-to-day operational needs. This is where working capital comes in.
Using working capital means using your current operations to fund your current operations. In other words, using your cash, inventory (by selling it), and accounts receivable (by collecting it) to pay your current expenses (like salaries, rent, utilities, and insurance). This requires careful budgeting and keeping a close watch over cash flow.
Business line of credit
A business line of credit works almost like a business credit card. Lenders give borrowers a credit limit, which they can draw on as needed. The amounts borrowed are often paid back with interest when due. Funds related to lines of credit are typically accessible through a mobile app or a business checking account.
Other types of floats in finance
In finance, floats come in various forms. The following are some common types of floats in finance.
Cash float
A cash float is when there’s a brief delay between the movement of funds from one bank account to another.
Examples of cash floats include receiving a customer’s check but not immediately cashing it, or paying a vendor’s invoice, but the payment hasn’t been processed through the banking system and subtracted from your bank account.
Disbursement float
Disbursement float is a type of cash float when the cash in your bank account is higher than the equivalent amount in your company’s accounting system. A disbursement float can happen for several reasons, including when you pay suppliers via check and the supplier doesn’t immediately process the check.
Disbursement float can also occur with electronic payments because of bank processing times and weekend or holiday transactions.
Collection float
Collection float is another type of cash float when the actual cash in your bank account is lower than the equivalent amount in your company’s accounting system. Collection floats occur when you receive check payments from customers but don’t immediately cash them at the bank.
Net float
The net float is the total of all cash floats, including the collection and disbursement floats. Big companies that handle many check-based transactions often have bigger net floats.
Stay free of credit card floating
Ditch the credit card float by paying balances in full and tracking spending against your budget. Because of their high interest rates, credit cards should be the last resort for paying expenses or accessing cash. Instead, explore other lending optionsto avoid finding your business in the frustrating debt trap.
Credit card float FAQ
How does using a credit card float affect my financial health?
A credit card float has the potential to seriously destabilize your finances, plunge you into a frustrating cycle of debt, and lower your credit score, especially if your utilization rate is high.
Can credit card float lead to debt accumulation?
Because it’s often easy to spend money you don’t have, credit card floats can easily lead to debt accumulation.
How can I recognize if I’m relying on a credit card float?
Signs that you’re in a credit card float include:
- Not paying your balance in full.
- Using multiple credit cards regularly to cover expenses.
- Having a bank balance consistently lower than your credit card balance.
*Shopify Capital loans must be paid in full within 18 months, and two minimum payments apply within the first two 6 month periods.
