Consider a line of credit for your business
Business line of credit basics
- The balance is usually revolving, with interest charged only on the drawn amount.
- Business lines of credit typically are unsecured.
- Lenders evaluate the company’s credit standing and revenue.
- Unsecured lines of credit often carry a higher interest rate.
Business owners can take out lines of credit to make purchases or cover expenses.
Business lines of credit can differ in certain ways and are often not secured by any asset. Lenders will typically extend the credit based on company’s credit standing and its revenue.
It is important to note that credit lines for commercial uses differ from a term loan. They are more like a credit card. The lender, typically a bank, allows a maximum limit that can be drawn upon. The credit line is usually revolving, meaning it can be drawn upon and paid off to replenish the balance.
The line typically is extended for a fixed draw period of several years, after which any drawn amount must be paid in full, or the outstanding balance will be converted into a loan with payments. The borrower pays interest only on the amount that is drawn.
A business line of credit is usually not easy to obtain. Companies often are asked to produce tax statements, a list of vendors, credit references and anticipated revenues. If the company is planning to use the line to expand the business, a lender may evaluate the project’s profitability.
Businesses most commonly take out lines of credit to manage their cash flows and fund operations. A company, for example, may periodically have a shortfall in cash while waiting to be paid by its customers for goods and services. Some companies also experience a cash shortfall at certain times of the year, and draw on lines of credit to pay salaries and fund operations through the slow months, and payoff the balance during the seasonal peak. The business also may maintain lines of credit as a security blanket in case of emergencies.
Good for small businesses
Lines of credit are particularly useful for small businesses getting started because they can be used for many purposes. Lenders, however, are often reluctant to approve them, unless the company has an established track record. To overcome this obstacle, the U.S. Small Business Administration (SBA) has developed four targeted credit-line programs that provide working capital and funds to finance property improvements under the umbrella of the CAPLines program. The owner will obtain the line through a lender, and the SBA guarantees the credit. Smaller companies have been able to secure lines of up to $5 million through this program.
Although credit lines tend to be more flexible than business loans, companies shouldn’t use them as a blank check to spend freely. Lenders generally advise companies against taking draws on their credit lines to cover business losses and keep the business afloat. Businesses also are warned against maxing out the credit line or carrying a large debt on the line for long periods. It is good idea to periodically pay down the existing balance whenever possible, as a means of improving the company’s credit standing and avoid interest charges.
Unsecured lines of credit typically carry higher interest rates than traditional loans. As a result, generally speaking, lines of credit are considered more suitable to fund smaller recurring expenses and manage cash flow, rather than for making large, one-time purchases.