Understanding a Business Line of Credit and How it Can Help Your Business Grow
A business line of credit is a versatile financial resource that provides your business with the flexibility and stability essential for success. Unlike traditional loans, a line of credit offers access to funds when needed, helping to bridge cash flow gaps, cover unexpected expenses or seize growth opportunities. Let’s break down the fundamentals of a business line of credit, explore how it works and explain how it can help your business.
Effectively Using a Business Line of Credit
Effectively using a business line of credit requires strategic planning and disciplined financial management. A business line of credit can be particularly effective if your business has a longer sales cycle. Typical scenarios include covering payroll or rent during slow revenue periods, purchasing inventory or funding marketing campaigns to drive growth. Your business can operate and pay these expenses while you wait to collect payments from clients or vendors. A line of credit is ideal for addressing temporary financial needs rather than long-term investments or fixed-asset purchases. In addition, there is value in opening a business line of credit, even if you don’t plan on using it immediately. Having the line of credit available can help if your business is in a pinch or a cash flow gap arises. A few additional tips include:
- Avoid maxing out your credit line so you can reserve funds as a financial safety net.
- Monitor your cash flow to ensure you can repay the borrowed amount.
- Draw funds only when necessary.
- Make timely repayments to minimize interest costs.
How to Get a Business Line of Credit
When establishing a business line of credit, your trusted banking partner will collaborate closely with your business, gaining a deep understanding of your industry and unique needs. They can assess how quickly your assets convert to cash, ensuring a tailored line of credit that aligns with your cash flow cycle without overextending your resources. Each balance sheet item carries a distinct collateral advance rate, which is key in determining the optimal credit line size. Additionally, evaluating your business’s stability, past and current performance trends, year-to-date profit and loss and overall financial health is essential to establishing the right financial solution.
Misconceptions
One of the biggest misconceptions about business lines of credit is that you need to make payments, even if your business doesn’t use the line of credit. No payment is required if there is no balance on the line of credit. Another common misconception is that business lines of credit are good tools for long-term debt. However, if your business wants to pay long-term debt (any debt over 12 months), you should consider a loan with a set repayment schedule and defined interest rate. A business line of credit utilizes a floating variable rate, which can change depending on the overall health of the U.S. economy.
Business Line of Credit Versus Credit Cards and Loans
A business line of credit provides established short-term capital needs in the form of 30 to 90 days to draw from when a gap in a cash flow cycle occurs. The payment is typically interest only, which provides flexibility for your business. Once receivables are collected, your business can use those funds to pay the business line of credit. Interest rates are much lower than credit card rates and are usually tied to the Wall Street Journal Prime Rate. A business credit card is ideal for any expense that can be paid in full in 30 days or less. However, for any expense over 30 days that cannot be paid in full, a business line of credit should be the preferred instrument to draw from as it has greater flexibility with a typically lower interest rate. A loan with a definitive payment schedule and maturity should be considered for any expense exceeding one year.
The Bottom Line
Engage your financial institution when your business is profitable to establish a line of credit. Have open and transparent conversations to determine the right size of the line of credit. Your trusted banker will help determine a loan that is not too small, where you have to come back to ask for an increase, or too large, which would enable your business to overextend itself.
Are you ready to seize opportunities for your business with a line of credit? Connect with our team to discuss your unique business needs.