Find out all about a business line of credit, and whether it is a good fit for your company’s needs.
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A business line of credit, also commonly known as revolving credit provides borrowers with access to a pre-approved sum of capital. Think of it as a credit card; it’s a facility you can draw from as and when you need, and interest is charged only on the amount that is drawn. When the amount drawn is repaid, your credit limit goes back up.
Lines of credit generally fall under two main categories: secured and unsecured. Secured lines of credit require that borrowers put up business assets as collateral. Beyond commercial properties, a line of credit may also be backed by inventory, equipment or invoices. With unsecured lines of credit, assets aren’t required as collateral - yet lenders typically require personal guarantee and a general lien.
Common uses for a business line of credit include:
Manage unforeseen expenses: A line of credit can serve as a cash cushion for unforeseen expenses. It’s not uncommon for small businesses to open a credit line in advance, and use it for funding unexpected costs as they come up - such as equipment replacements or maintenance repairs for utilities.
Capitalise on unexpected opportunities: With external financing, small businesses are better positioned to take advantage of time-sensitive opportunities they might have to forgo otherwise, such as limited-time offers from suppliers.
Combat seasonality: For seasonal businesses, a line of credit is a great tool for balancing cash flow across the peak and lull periods. Businesses typically use a credit line for financing inventory and marketing expenses to prepare ahead for the busy season, or funding payroll expenses during the low season.
Offer trade credit more comfortably: Offering trade credit to your customers can lend your business a competitive edge - yet it’s a move that also comes along its own set of risks, such as creating negative impacts on your cash flow. With a credit line in place, you can feel more comfortable about extending trade credit as you’ll have a financing facility to tap if there are delays in payment.
The following are general requirements that can help you assess if a line of credit is a good fit for your business:
You’re looking to cover short term business expenses: A line of credit is best suited for short term needs, such as covering cash flow gaps or seasonal expenses. That’s because one of the biggest advantages that it offers is flexibility - you can draw from your credit line anytime, and there aren’t restrictions on what you can use the funds for. Therefore, you’ll want to avoid using up the line for long term expenses, as this can limit your access to funding should urgent situations crop up.
You aren’t certain about how much you will need: With a line of credit, you’ll have quick, flexible access to a pool of funding you can tap whenever you need. This makes it a great option for situations where you can foresee that there’ll be an upcoming need for external financing, but aren’t exactly sure about how much you’ll require.
You need to finance recurring expenses: As long as you don’t exceed the pre-approved limit, and are able to fulfill other requirements set by your lender (such as making timely payments), the structure of a line of credit lets you dip into your amount frequently - which makes it an ideal solution for covering recurring business expenses.
You need quick access to funding: While the application processes and speed of funding will vary depending on which institution or platform you’re obtaining funding from, certain online lenders can approve your application and provide access to funding in just 24 hours - and these are the lenders you should be looking at if you require immediate funding.
Take a strategic approach, and time your application right
The best time to apply for a line of credit is when you don’t need it. That’s because you’re far likelier to get your loan approved when your business financials are in good shape.
Look ahead into the next 12 months to examine your capital needs. If you foresee an upcoming need for external funding, you can then take steps - such as improving your credit profile if you have a low credit score - to ensure that you’re better positioned to qualify for better loan terms or more financing options when you make your application.
Start off with a lower limit, and work towards a larger line of credit over time
You’ll likely start out with a lower limit when you first obtain a line of credit - particularly if your credit profile isn’t in great shape. Even if the credit limit you’re offered is lower than the sum that you currently require, it can be helpful to take out the facility, and gradually work your way towards a larger line of credit.
While the requirements will vary across lenders, they will increase your limit or be willing to renegotiate your repayment schedule when you’re able to hit new benchmarks down the road - such as when you’ve increased your credit score, demonstrated that you have strong cash flows consistently or have achieved sustained revenue growth.
Small businesses - in particular, newly established ventures without a solid credit history - often find it challenging getting a line of credit from traditional lenders, as they aren’t able to meet the stringent lending criterias imposed. This may include having a minimum operational history of two to three years, or a minimum annual revenue of $200,000.
As such, small business owners are increasingly turning to online lending platforms, where they can benefit from more flexible lending criterias, as well as streamlined processes and quicker access to funding.