Business Line of Credit: The Basics
Problems with money flow and other uncertainties are only two of the many difficulties that might arise when you own a business. Unofficially, it’s good practice to have a financial safety net in a place far before you actually need it. A company that waits until it’s in a tight financial spot before applying for a loan may find itself without the funds. That’s why it makes sense for some companies to get a credit line.
In times of low sales, a business line of credit can be used to meet payroll and supplier fees as well as unanticipated costs. Having access to a line of credit might assist small business owners to meet their immediate financial obligations.
It is possible to secure a line of credit for a business through a bank or an online lender. Business lines of credit offer an alternative to typical small business loans, but it’s crucial to weigh the pros and cons of each before committing to one.
Find out how business lines of credit function and evaluate many top choices from both online and traditional banks below.
What Exactly Is a Business Line of Credit?
A line of credit (LOC) for a business is a revolving loan that allows the borrower to draw from a set amount of money as needed to cover unexpected or urgent expenses. A line of credit (LOC) is one option available to businesses for satisfying their immediate needs for working capital and can be put toward items like:
- Acquiring inventory
- Performing maintenance on essential parts of business equipment
- Budgeting for an advertising campaign
- Filling a cash flow void caused by seasonal fluctuations
In order to satisfy daily working capital demands and other short-term financial necessities, a business line of credit can be an invaluable tool for small firms that adopt a strategic approach to securing the financing they require. This gives them the opportunity to apply for and get pre-approved for any loans they might need in the future.
In order to finance growth and other revenue-generating projects, many organizations employ a line of credit as part of a comprehensive capital access strategy that also includes short-term and longer-term financing.
How Does a Business Line of Credit Work?
Revolving credit is the most common form of credit extended to businesses. Revolving business credit lines function similarly to credit cards in that they establish a maximum loan amount. You have the option of either carrying a balance and making at least the minimum payment each month, or paying off the debt in full; interest is only accrued on the amount that you borrow.
With a revolving credit line, you are able to borrow additional cash as you pay back the amounts that you have borrowed without having to submit an application for a fresh line of credit. However, not all company credit lines permit revolving debt; some necessitate a new application once the original loan has been repaid.
There are two primary types of business lines of credit: secured and unsecured.
To qualify for a secured line of credit, borrowers must provide collateral. That might be anything from your home to your company’s machinery and inventory and even its receivables. A secured line of credit may be more accessible if your firm is new, has minimal revenues, and has no existing business credit score. Never put up something of value as collateral that you can’t afford to lose.
In order to qualify for an unsecured line of credit, a business must meet certain revenue, personal credit, and business history thresholds in addition to meeting the regular credit requirements. Proof of your success in the past will increase the likelihood that a lender will trust you with a loan.
Business Line of Credit vs. Business Loan: What’s the Difference?
A business line of credit is considerably different from a business loan from the lender’s standpoint (both online and traditional lenders).
When deciding whether or not to provide a company with a loan, a lender will often look at the company’s credit profile. In order to determine whether or not a company will be approved for future credit when it taps into a business line of credit, lenders look at the company’s credit performance today. These are two quite different scenarios from the lender’s perspective, which may explain why the requirements for obtaining a business line of credit are stricter.
However, that’s not the only distinction between a business loan and a business line of credit. After getting accepted for a business loan, the company receives a certain sum of money all at once. The balance of a periodic payment plan is normally repaid in a series of equal installments over a set time period, or term.
A business line of credit terms is more malleable than those of a traditional small business loan. Essentially, a business line of credit is a predetermined amount of money that a company can borrow, payback, and then borrow again. The majority of lenders stipulate that the business line of credit balance must be paid off in full at some point throughout the loan’s duration.
Who Offers a Business Line of Credit?
A wide range of financial institutions and online lenders offer lines of credit for businesses.
- Credit unions and banks. A variety of business lines of credit, such as SBA lines of credit, secured business lines of credit, plus unsecured business lines of credit, are available from banks and credit unions.
Though these institutions may provide business lines of credit at reasonable interest rates, certain standards must usually be met to be approved. You will probably need several years of business experience, along with solid financials and a good credit score.
In addition to potentially higher interest rates and costs (particularly for greater credit lines), banks and credit unions may also need physical collateral to secure your credit line.
- Online lenders. When it comes to establishing a company line of credit, online lenders typically have greater latitude than traditional financial institutions like banks and credit unions. There are internet financial institutions that will work with new enterprises or those with poor credit.
Traditional banks may take weeks to grant a business line of credit to a small business, but online lenders can often do it in a matter of days thanks to their faster application processes and lower fees. However, these creditors typically offer higher interest rates and lower loan limits than banks.
How to Qualify for Business Line of Credit
Applying for a business line of credit could be the best option if you require a flexible finance solution to handle continuous cash flow issues. However, the application procedure can be time-consuming and in-depth, requiring you to provide sensitive information about yourself and your company.
In order to qualify for a business line of credit, you will need to meet certain criteria, some of which may vary depending on the type of business loan you decide to pursue.
- Credit history – Your personal and company credit scores will be among the first pieces of information a lender will look at. Your lender can better gauge your repayment likelihood with this data at hand. A score of 700 or higher will get you the best interest rates and terms available.
- History of Business – Most creditors require that your company has been operational for a minimum of two years before they will consider lending to you. Being a startup doesn’t necessarily rule out funding opportunities, but you may need to provide collateral.
- Revenue and cash flow – If you want to secure financing from a bank, you’ll need to show that your company has reliable and consistent cash flow. They want to see evidence of steady expansion over time. Bank statements, tax returns, P&L statements, and cash flow estimates will all be required.
When Does a Business Line of Credit Make Sense?
A business line of credit’s usefulness will depend on the details of your particular company’s financial situation. Organizations that would benefit from a line of credit include those that:
- Want to increase their financial resources.
- Have no clear goal in mind.
- Feel the shifts that come with the seasons.
- Have more short-term costs, like replacing stock or paying for unplanned expenses.
- Have consumers who pay you after more than 30 days have passed.
- Need a quick way to get some extra cash.
A business line of credit can be utilized in various ways, and it typically has minimal requirements than a traditional loan.
Keep in mind that the interest rate you are granted for a business line of credit may increase throughout the duration of your repayment if it is a variable rate. Additional fees may cause the total cost to exceed your budget. It may be more challenging to qualify for one of these business lines of credit. Many lenders place caps on how much you can borrow, typically limiting you to amounts far lower than those available for conventional company loans.
A line of credit for your company can be an invaluable resource for funding other ventures that generate profits and helping to fuel your company’s growth. They can be used to bridge the gap between cash inflows and outflows, to keep seasonal firms running all year, and financial investments that add value and multiply results when used in tandem with other financial instruments.
However, carefully consider whether or not a business line of credit may be beneficial by looking at your company’s unique financial situation. Before applying for a fresh line of credit for your business, make sure you review the fine print to discover any hidden charges and ensure you fulfill all eligibility conditions.