Business Line of Credit Guide

Every business owner and every small business requires cash flow. A lot of times businesses need a little boost with a little help from the bank. There are many different vehicles available to business owners in order to get this money. Some may use funding sources from friends or family. Crowdfunding is also an option, currently go fund me pages are on the rise to even have potential strangers fund your business. Some people use a method called factoring which means a business can sell their accounts receivable to a financial institution. If you have a home that has some built in equity than you may be able to take out a home-equity loan. If you have good credit you may be able to open up a credit card for a substantial amount. Or finally, your other option may be a business line of credit.

Business Lines of Credit are a financial instrument typically used for an organization’s short-term working capital needs, such as inventory purchases, future project costs or company payroll. Lines of credit are mainly to help even out your cash flow. Below we are going to explore the basics of this financial instrument.

How does a small business line of credit work?

A business line of credit is different than a loan. It uses revolving credit. Revolving credit is basically when you are approved for a balance but then you only use what you need. You don’t get the total balance, you only finance what you actually use. Once you pay off the balance, or what you used, then the credit becomes available again…hence the term revolving. You get a max approval amount and then you have the flexibility to make draws as the need arises up to that max amount. This is different than a credit card because you are given cash and are not required to use vendors who accept credit cards. Once maxed out, you can continue repaying and reusing the funds within your line of credit provided you make payments on time and never exceed your credit limit.

What is a business line of credit good for?

The biggest downfall of a credit card is exactly that…it is a credit card, it is not cash. Cash is king in business. Most business have trouble with cash flow and that is exactly what a business line of credit can provide for you. It is basically like a savings account that you can dip into when necessary. Have access to untapped cash is priceless for a small business. Another thing a business line of credit is helpful with is to aid with expanding your business. This means you can hire new employees, buy inventory, renovate your location, or just simple cash flow and work capital.

How is it repaid?

With Business lines of credit you are able to repay the money used by a set period of time. The period of repayment time is typically 6-12 months and the rate that is used are approximately 1-3% of your outstanding balance. This rate is also in addition to interest charges and fees. Basically the rate that is determined is based upon the amount drawn, the cost of funding and also the term.

Types of Lines of Credit

Lines of credit can be broken down into two main types. There are unsecured and secured lines of credit. An Unsecured line of credit does not require collateral which is quite an advantage. Another advantages to this type is that the line of credit is usually smaller in length. It may be smaller in length but the interest may be a little higher. The other type is a secured line of credit. Secured lines of credit need to be backed by something, because of this you are typically charged a cheaper rate. A riskier endeavour for lenders means it must be backed by some sort of asset. An example would be property, inventory, accounts receivable, etc.

Make sure to consider all of these factors before applying for an account. Things aren’t always as easy as they sound. Most lenders will take into account the time in business, credit score, annual revenue and less than 3 negative occurrences in your bank account in the last 90 days.  Be sure to do your due diligence and invest in the proper vehicle for your business.