A small business line of credit helps entrepreneurs maintain a constant supply of cash to keep up with recurring expenses and the ebb and flow of seasonal changes in the business. For the 50% of businesses owner who has experienced cash flow problems, a small business line of credit can be a necessary lifeline. .
You may be thinking: “My business is profitable, we don’t need additional cash reserves.” But many businesses with and without cash flow issues keep a line of credit handy for unexpected growth or expansion opportunities. A business line of credit is a flexible, often low-cost way to cover short-term financing needs regardless of the nature of those needs.
- How does a business line of credit work?
- What is a secured vs. unsecured business line of credit?
- What are lines of credit typically used for?
- Business line of credit requirements
- Best business lines of credit
How does a business line of credit work?
A line of credit, or revolving line of credit, is a flexible loan option for businesses. Businesses are allocated a specified maximum amount of capital available to them through a lender based off certain factors such as current cash flow and business credit rating.
Unlike a business loan, where a business must make regular daily, weekly, or monthly payments to repay the loan, a business line of credit is only repaid when the business draws from the line. Interest will also only be charged only when you decide to pull money from the line. The business then decides when, if, and how they would like to use that capital.You will have a specified repayment period, but, like a credit card, there is no penalty for paying early (in fact, it is encouraged).
Although interest is only charged once you use the line, there may be a monthly maintenance fee for letting your line of credit sit unused. For any line of credit you consider you need to carefully read the terms offered by the bank or lender to make sure you understand any associated fees.
What is a secured vs. unsecured business line of credit?
A secured line of credit is a line in which the borrower puts up collateral as a security deposit on the line of credit. Putting up property as a form of collateral is common, but this could also be other items owned by the business, such as equipment or inventory.
Secured lines are may be preferred over unsecured lines by both lenders and borrowers. The lender is taking on less risk, so they will usually grant a higher credit maximum at a lower rate for secured lines. New businesses or businesses with poor business credit might only qualify for a secured line of credit because of the inherently higher risk.
In contrast to a secured line, an unsecured business line of credit does not require collateral assets. Unsecured lines of credit are more expensive because the lender assumes higher risk. Credit cards are a type of unsecured line of credit. Businesses with many years under their belts and stellar business credit reports are more likely to qualify for unsecured business credit lines at reasonable rates.
What is a business line of credit used for?
If you are looking to fund a one-time project or a very long-term project, a business loan might be a better fit for you than a business line of credit. Here are a few ways you might use a business line of credit::
- Your business has seasonal fluctuations — perhaps your sales take a dip in the summer.
- A line of credit will help during the periods of low sales.
- Your clients take 30 days or longer to pay you for products or services you provide. You might need a line of credit to cover the interim time until you are paid.
- You land a huge client and need credit to cover the cost of materials while you ramp up work for the client. A business line of credit can cover expenses during production.
- You have the opportunity to receive a discount if you pay a particular bill early — if the resulting discount is significant, you can cover the bill with your line of credit while you wait for cash flow to catch up.
What are the requirements to qualify for a business line of credit?
A lender will look at your time in business, your personal credit score, annual revenue, the strength of your cash flow and may even look at the strength of your business credit to qualify you for a business line of credit. If you don’t yet have a bank account set up for your business, and if you are not yet building business credit, it will be wise to start if you suspect a future need for a business line of credit.
An additional factor that a lender will look at is your ability to secure the line. Again, a secured line will be a less expensive option, so if you can put up collateral for the line of credit, a lender will be more likely to approve your application.
Like with many financing options, the best time to get a line of credit for your business is well before you actually need it. You’re more likely to qualify for the best terms when your business is in great shape and has no cash flow problems.
Remember: you’re only charged interest on the amount that you borrow. If you secure a line of credit now you’re not obliged to use it, but it will be there when you do run into tight cash flow situations.