Cash flow can be tricky to manage for a small business. When cash runs low, you can be caught between waiting for payments from customers and needing to pay your own bills. You may also find that you need access to additional cash to fund an increase in demand from your customers but don’t have enough on hand.
A business line of credit can help a business manage these challenges. In fact, lines of credit are a very common way for small businesses to fund operations. Access to funds allows you to draw on the line when you need it and repay it when cash comes in.
From a startup to an established company, every small business can take advantage of a small business line of credit. Its convenience and flexibility put you in control compared to other types of loans.
What Is a Business Line of Credit?
Think of a business line of credit almost like a credit card. You will be approved by a lender for a maximum amount of funding. When you need money, you make a withdrawal from the line. A minimum amount due will be calculated, allowing you to choose between paying the minimum or paying more on the line.
Other types of business loans will give you the entire amount upfront and have fixed payments over a specific amount of time. When you make payments on these loans, you cannot access the unused portion of the loan again. These are “term loans” and often have a specific purpose, such as buying expensive equipment or real estate.
Secured vs. Unsecured Loans
A secured business line of credit means that you will back up the loan with some of your business assets. Your assets – the collateral on the loan – can be seized by the lender if you were to default on the payments.
This is less risky for a lender because if you are unable to make payments, the loan can be offset with your collateral. You may get more favorable terms from a lender if you pledge collateral. However, this is also more risk for your business because if you are unable to make payments, you will also lose your asset.
An unsecured business line of credit has no collateral. The lender will look at your business’s operations and decide an amount to approve. If you have concerns about pledging collateral, you may want to look for an unsecured line of credit.
When to Use a Business Line of Credit
You can use your business line of credit to cover short-term expenses or gaps in your cash flow. Unlike business loans that are for a specific purpose, you can choose how and when to use your business line of credit. Some examples include:
Payroll. If you have a cash flow shortage, you can use your business line of credit to cover your payroll expenses. You can also use the line if you need to hire additional employees to meet demand ahead of when you receive payment from customers.
Operational Expenses. You can use the line to cover insurance, supplies, utilities, property taxes, vehicle or travel expenses, rent, and more.
Equipment or Inventory Purchases. Sometimes you need to replace equipment or buy new equipment or inventory ahead of having cash available from operations.
Repairs and Maintenance. Sometimes the unexpected will come up, and you need to make a major repair. You can access the business line of credit to pay for the repair.
Advertising or Marketing. Additional marketing efforts can bring in a lot of new business, but it takes an investment to make that happen.
Slow Paying Customers. You may have a period of time where your customers are slow to pay their invoices, which impacts your access to cash.
Seasonal Business. If you are a business that operates seasonally, you may have times during the year where revenues are low. You can use the line of credit to tie over your expenses until your busy season.
Qualifying for a Business Line of Credit
When you apply for a business line of credit, lenders will typically look at several factors.
- Credit Score: As a small business owner, lenders will review your personal credit score.
- Revenues: You will need to provide information about how much revenue your business generates.
- Collateral: Whether you are pledging an asset as collateral can factor into the credit decision.
Once a lender has collected the information, a decision will be made about your line of credit request. If approved, the lender will let you know the maximum amount of your line.
You may need to provide documentation about your business. This may include bank statements, personal identification (like a driver’s license), and other information.
When you are looking for a business line of credit, you should ask the lender how quickly the loan can be approved. This will impact the funding of the loan and makes a difference if you are in a situation where you are currently short on cash.
It helps to apply for a business line of credit before you have an actual need. That way, you have access to the money in the event that you need it.
Applying for a Business Line of Credit
Having access to a business line of credit can be a lifeline for a small business. It ensures that you have the ability to meet the challenges of your business. Whether you are covering a cash flow shortage or looking to grow, a business line of credit gives you access to funds.