When your company needs cash to cover impending expenses, you don’t have time to waste compiling overly detailed loan applications. Having a line of credit in place provides access to a guaranteed amount of money any time you need it so that you never find yourself in a financial bind.
If you routinely require small amounts of money to keep your business going rather than large lump sums for occasional expensive purchases, a business line of credit could be right for you.
A small business line of credit (LOC) allows a borrower to draw against a lender-specified amount of financing on an as-needed basis. The advantage of a business credit line is that you only pay interest on the funds you actually draw, so you’re not stuck paying interest on capital you don’t have an immediate use for. Here are a few small business line of credit options to consider:
Lines of Credit vs. Business Loans
There are many types of small business loans, but a line of credit is somewhat different. The choice between applying for a business loan or a line of credit loan depends on how much cash you need and what you intend to use it for. Business loans typically:
- Provide one-time lump sum payments
- Require repayment at a fixed interest rate
- Have stable, predictable monthly payments
- Include closing costs or early repayment penalties
- Lines of credit, on the other hand, are similar to credit cards in the way the money is accessed.
If you qualify for this type of loan, you can expect:
- A set amount of money to borrow against
- Flexibility to borrow as much as you need at any time
- Monthly payments calculated based on how much was borrowed
- Variable interest rates lower than the prime rate
- A draw fee for borrowing against the credit line
- Few or no closing costs
Traditional line of credit:
The traditional line of credit is typically meant for experienced business owners with proven business models. Which makes sense since the credit maximums are sizable, the rates are lower, and the requirements demand higher credit scores and annual revenue reporting. If you’re a business owner taking out a line of credit, you’ll be spending that flexible cash on seasonal business expenses, payroll and other operational costs, insurance against emergencies and for sudden opportunities. In other words, as a capital cushion. It’s there for you when you need it.
Short-term line of credit:
The difference between a short-term line of credit and a traditional line of credit is more or less the same as the difference between your typical short-term loan and conventional bank or longer-term online loan Therefore, a short-term line of credit has a higher interest rate, lower credit maximum, faster turnaround time and looser application requirements. Unlike the traditional line of credit, the short-term line of credit is generally offered by alternative lenders rather than by banks. The point isn’t that one is better or worse, they appeal to different groups of business owners. Those with lower credit scores, smaller annual revenues, or newer businesses might only qualify for a short-term line of credit. And although the short-term line of credit tends to be more expensive, its value lies in giving younger small businesses the opportunity to maintain a flexible pool of capital. A small business line of credit provides flexibility that a regular business loan doesn’t. With a small business line of credit, you can borrow up to $100,000 and pay interest only on the money borrowed. You then draw and repay funds as you wish, as long as you don’t exceed your credit limit. Need to manage cash flow? Buy inventory? Pay for a surprise expense? Then a business line of credit makes sense.
Invoice-backed line of credit:
The basic idea behind invoice financing (also called accounts receivable financing) is that, sometimes, customers take a long time to pay you back -- but you might not be able to wait. Instead of relying on short-term loans to cover operating costs, or digging into your savings, you could just get those invoices paid right away -- although you’ll have to shoulder the costs of that speed and efficiency. An invoice-backed line of credit follows the same logic. The value of your invoices determines your credit maximum, and you can draw capital as needed instead of relying on your customers to pay on time. And as your invoices increase, you’ll typically have access to more cash from the line of credit as well.
When to Use a Line of Credit:
Certain businesses, such as retail establishments, benefit more from lines of credit because of the predictable variations in cash flow. Seasonal changes in sales mean earnings fluctuate on a set schedule, and extra money is often needed to continue operations during slow times. When you’re able to anticipate these financial needs, you can rely on a line of credit to provide security.
A line of credit is also useful when:
- You require a short-term boost in working capital
- You’re unable to meet a payroll deadline Inventory needs to be increased or replenished
- You need to cover expenses associated with hiring new employees
- Marketing efforts need to be increased in anticipation of a special event
These types of expenses may not be specific or concrete enough to allow you to qualify for a regular business loan. However, since line of credit loans are given based on financial standing rather than a specific spending plan, you can still get the funds your business requires.
Applying for a Line of Credit: The Basics
Like a business loan, a line of credit may be secured or unsecured. Secured credit lines need collateral to back them up. Unsecured lines are guaranteed by your business and require more trust on the part of the lender. In both cases, you’re at risk of loss should you be unable to make payments. The lender will either take possession of your collateral or have the choice to sue you for what you owe.
To avoid these problems, work to build up a good credit score for your business and yourself. Have a dedicated business bank account, and stay on top of all your payments. Keep detailed records of cash flow, profit and loss, accounts payable and receivable, revenue streams, assets, and income. Most lenders will want to see this information when deciding whether or not to extend a line of credit to your business.
Benefits of a Business Line of Credit
You may wonder why it’s worth the effort to go through the application process for a line of credit when a credit card offers similar borrowing options. However, credit cards can hit you with fees and penalties subject to change with little warning. Interest on a line of credit is often lower, and making regular payments also builds up your credit rating.
When compared to a business loan, the monthly payments on a credit line tend to be smaller, and you don’t have to worry about the money “running out” when you need it most. Instead, you have a set credit limit to draw from for the duration of the loan term. As long as you’re diligent about paying off what you borrow, you won’t be saddled with the specter of long-term debt.
Mistakes to Avoid With a Line of Credit
While this type of business loan may sound like the perfect fix for just about any cash flow problem, it’s easy to slip into bad habits or make poor judgment calls. To make a business credit line work for you, be careful not to fall victim to these financial mistakes:
- Waiting until the last minute to apply
- Missing out on potential “upgrades” after improving your credit score
- Neglecting to ask if the lender reserves the right to “call” the loan
- Maxing out the credit line
It’s essential to be thorough when looking for a lender and careful when establishing a payment structure so that you don’t wind up in a tenuous financial situation.
With a business line of credit in place, you don’t have to worry about your company going under due to unexpected expenses or a particularly slow season. Be smart about how you use the money available to you, and your company will remain lucrative even during tough times.
Is a line of credit loan a good fit for my business?
While it’s ideal to have savings to help your business weather storms, the next best thing is to apply for a line of credit. Business credit lines were designed to help you meet short-term cash needs, such as purchasing supplies or additional inventory or covering operating expenses. Essentially, a business line of credit can help small businesses thrive and grow. A business line of credit is a good option to offset fluctuations in working capital when your expenses stay constant. A line of credit will give you access to funds to continue to pay bills on time or purchase additional inventory if needed. The advantage of a line of credit over a regular business loan is that interest is only charged on the funds you actually use. Additionally, your business can draw on the line of credit at any time that you need.