When owning a company, money can become a great stressor. A business line of credit (LOC) can help ease the heavy burden of finances. It can become a business owner’s most valuable financial tool to help tackle finances in a smart and strategic way. A business line of credit can ensure that a company has access to the necessary resources they need on a day-to-day basis. Not only that, a line of credit can help build value and success within your business.
What is a Business Line of Credit (LOC)?
A business line of credit (LOC) is a loan that allows access to a fixed amount of capital. It can be used to help meet short term business needs. Here are some examples of how a line of credit can be a tool for businesses to use for short-term capital requirements:
-Bridge a seasonal cash flow gap
-Finance for marketing
-Repair essential business equipment
It’s also important to note that there are two types of business LOC’s:
1. Secured Business Line of Credit
Since a line of credit is made for short-term usage, companies typically ask for short-term assets (i.e. inventory). In order to have a secured line of credit, a company must pledge specific assets as collateral. Typically, lenders don’t require capital assets (i.e property or equipment) to secure a line of credit. In a circumstance where the borrower is unable to repay the line of credit, the lender will claim ownership of any collateral and use it to pay off the balance due.
2. Unsecured Business Line of Credit
This type of line of credit does not require any specified collateral assets. However, a personal guarantee or lien is likely to be required. Due to the fact that no specified collateral is required for this LOC, it’s essential that a business has a stronger credit profile. This will be crucial in the qualification process with a lender. A strong business track record will also be important to qualify. Unsecured lines of credit are typically smaller. Additionally, interest rates are slightly higher.
How Does a LOC Work?
When you open a business line of credit, your business is allocated the stated amount of funds needed. There will be monthly statements that reflect the amount of credit used and also any interest charges (in a LOC, you only pay interest for the funds you use, as you use them).
A periodic payment plan will be determined between the lender and borrower. Weekly or monthly periodic payment schedules are the most common. When the credit is repaid, the credit limit becomes available to be accessed again. As previously mentioned, your payment, along with the interest, is based upon the funds you use.
Small LOC’s are typically considered $100,000 or less. These lines of credit operate a lot like a credit card account, with the advancements of using a credit card that is tied to the LOC or by checks issued for the account.
A business line of credit can become a powerful tool in your business. It can help fuel growth and profitability. You’ll be able to experience financial flexibility to cover any gaps in between normal cash cycles. A business LOC can also fund expenses that would build reputability in your company.
A Business Line of Credit vs. a Business Term Loan
If you ask a lender, a business line of credit and a business term loan are two very different things. For example, when a lender takes the time to evaluate your credit for a term loan, the primary thing they are looking at is the business’ credit profile to make a decision about the loan within that same day. For a business line of credit, the primary thing they are evaluating is the business’ credit performance today, to make a decision on the creditworthiness of the business when it can access the credit line. To us, that may not seem too different. However, to the lender, these are two very different situations. This can also explain why the qualification process for a line of credit is more thorough than a business term loan.
Truth be told, that’s not the only difference between a business line of credit and a business term loan. To explain this further, a term loan involves a fixed amount of funds, while a business line of credit does not. For a term loan, the business will receive a lump sum as soon as the loan is approved. Periodic payments are typically set in place for a term loan until the balance is paid in full. Your lender will be able to go over your payment plans with you in more depth.
In contrast, a business line of credit also includes some flexibility. Typically speaking, a line of credit is fundamentally a credit limit that can be borrowed by a business whenever they need it, repay it, and use it again. It’s important to note however, a lender will most likely require the LOC balance to be zero during the line of credit term.
When Should a Business Consider a LOC?
If your business consistently requires access to funds to fulfill short-term capital needs to manage your company’s daily capital requirements, applying for a line of credit may be in your best interest. To help clarify when a business should consider a LOC, here are some examples:
Example #1: A haunted house is a seasonal business. It generates most of its sales with the span of 2-3 months during the fall. A business like this could use a LOC in the offseason (if they have the cash flow to make periodic payments) to help bridge the gap between their off season and their busy season. One of the reasons why a LOC would be beneficial for this company is because it would allow them to maintain normal business operations throughout their income fluctuations.
Example #2: A marketing campaign can become a huge benefactor for a business and it’s profits. Marketing brings in new customers and can skyrocket sales. However, marketing is a sometimes large expense. A line of credit provides the opportunity to borrow funds that can be paid off by the marketing campaign.
Example #3: Holding off on payments for expenses while waiting for clients to pay their invoices can be stressful. A line of credit can be helpful for cash management to cover that time gap.
Applying For a Line of Credit
Most lenders prefer to grant a line of credit to a company with a track record of their numbers and revenues to support the flexible financing that a LOC offers. A new business that is not well established and doesn’t have a credit profile will have a more difficult time being approved for a line of credit.
As with a term loan, most lenders will require financial records and documents that show your credit worthiness. This is why it is crucial to be on top of your numbers. Track them daily, weekly, monthly, and annually. Talk to your accountant to receive help on how to portray these documents to lenders. Traditional lenders (banks and credit unions) will most likely require additional documentation that online lenders will not. To come off as professional, know ahead of time the documents that your lender will require of you and your business.
Some of the basic information that a lender may ask of you includes:
A business license
Bank statements from the last few months
A business bank account
Standard finance documents (Cash flow, AP, AR, etc.)
It is important that you come prepared to discuss the financial position of your company with your lender. Take the time to consult with your accountant or CPA on any questions you have about documents that show the health of your business’ finances.
If a lender grants you the line of credit for your business, it is equally important that you stay worthy of it.
Here are 3 Tips on Keeping a Business Line of Credit (LOC)
Periodically, take the opportunity to pay your balance. This will help you avoid keeping your average running balance near your credit limit, allowing your lender to build trust and value in your business.
To avoid making repayments difficult, refrain from using your line of credit to cover operating losses.
Planning ahead will be a great financial tool in running your business. Strategically plan out your capital needs for the year. This will help you determine when the best time will be to apply for a business line of credit. When lenders see that your business cash flow is strong, they are more likely to grant you a line of credit.
A business line of credit can become a powerful tool in your company to fuel growth and profits. A LOC offers financial flexibility, covers gaps during your less busy seasons, can fund expenses that will build value and amplify your success, and much more.