Small businesses are well-known as being the backbone of the economy. Often, in order to succeed, enterprises may seek out a business line of credit. Whether it is to secure inventory or expand, this type of credit is a valuable tool that, when used responsibly, can facilitate long-term business goals. Often, companies will use a line of credit in conjunction with other forms of business financing. A line of credit is a short-term solution to foster long-term results. Typically, business lines of credit are used to meet immediate needs; a small component of the bigger financial picture. Naturally, as with all financial matters, being thoroughly informed on the risks and advantages of a business line of credit is essential.
What is a Business Line of Credit?
The first step toward securing a line of credit is gaining an understanding and appreciation of what it actually is. Different from credit cards or standard loans, there are many unique traits that set these lines of credit apart from other financial arrangements.
Revolving Loan
A business line of credit is referred to as a revolving loan. In effect, it gives the business access to a set amount of funds. These can be used for a variety of purposes, though is not a viable long term solution.
What Is a Business Line of Credit Good For?
There are several useful applications for a business line of credit. When applied properly, this set amount of accessible capital can be very helpful to small enterprises. Examples of prudent applications include:
- Cash flow: If your business is experiencing dips in its cash flow, you can use the funds from the line of credit. The pandemic resulted in serious cash flow gaps due to mass business closures and a dip in consumer purchases. Other cash flow issues related to seasonal dips in transactions. In either case, a line of credit is a useful tool.
- Short term needs: Sudden expenditures like breakage of equipment or building code issues can be quickly remedied with a line of credit. It is particularly viable as a solution if the issue being repaired halts operations. Whether the issue is mechanical or technological, the short-term fix begets long-term results. Such is the ideal fit for these purchases.
- Marketing expenses: If you’ve rebranded or are looking to approach a larger market share, financing your campaign is a major concern. A line of credit can offer you funds upfront to use towards future business success.
- Filling purchase orders: Perhaps one of the best-suited uses of a line of credit is culminating inventory. Often, businesses will experience a surge of orders though lack the liquid cash to fill them. Instead of risking losing long-term clients, a line of credit gives you the money needed to fill your inventory demands.
How Does a Business Line of Credit Work?
Once you know what the line of credit will be used for, you can move on to determining the best arrangement terms. There are different approaches to lines of credit, each with its own advantages and disadvantages.
Secured vs. Unsecured
The first thing to determine is whether you will be putting something up as collateral. Generally, a creditor will request something to hold against the value of the loan. This can be funds held in your business account, and those accrued during the period of the loan, or your inventory. Usually, for this type of loan, real estate or larger-scale collateral like business equipment, is not necessary as collateral. With secured loans, if you are unable to pay the amount owing on your credit line, the creditor can seize the asset to pay off the loan.
The other option is an unsecured loan, where you do not need to provide any collateral. In this arrangement, you will be expected to have a good credit history and a strong track record of success. Typically, the lender will request a lien against the business, even though no specific collateral is declared. Bear in mind that with unsecured loans, since there is no collateral, the interest tends to be higher and the lending limit lower.
Accessing Your Funds
Typically, lines of credit are granted based on your business history and current state of your credit. The funds offered are directly proportionate to your standard revenue. It is important to note that the credit line is not open-ended. You get a set amount of funds you can access at any given time. For instance, if you get a credit line of $10,000 then use $2,000, you will have access to $8,000. However, once you pay off the $2,000 plus interest, you once again get access to the full $10,000.
Interest Arrangements
Unlike with short-term loans, you only pay interest on the funds you use. This means that pursuant to the example above, instead of paying interest on the full $10,000, you would only pay interest on the $2,000 you use. Ensure that you check the frequency of interest charges to prevent any over or underpayments.
How Do You Apply For a Business Line of Credit?
The first step to getting your line of credit is finding the lender. Ensure that you compare and contrast lenders. Gain an understanding of funding limitations and interest rates. Figure out which option is most suitable for your needs and choose the lender that meets those requirements.
Check Eligibility Requirements
Before reaching out to the lender, ensure that you meet the requirements for the line of credit. Check their expectations for your assets, the amount of time your business has operated, and your average annual revenue. Provided you meet these requirements (and can prove it), you can continue to pursue the credit line.
Prepare Your Documents
Ensure that your paperwork is in order. Figure out what paperwork is needed and ensure that you have it on hand. Typically, you will be expected to provide bank statements for the last quarter, business tax returns, proof of a bank account, business registration, and other documentation like your accounts receivable and payable, and cash flow history.
Fill Out The Application
Once your paperwork is together, proceed to complete the application. Currently, many applications are digital to adhere to social distancing protocols. Ensure that you follow all instructions, including file format. Submit your application completely and include viable contact information.
Wait For Results
Lastly, you need to wait for the results. Some lenders are more efficient than others; so, if in doubt, consult them directly to learn about standard wait times.
Can I Increase My Business Line of Credit Limit?
If your business is growing, it’s likely your cash demands are rising as well. Should you require a more substantial line of credit, you will need to approach your lender directly. Bear in mind that you will need to prove your business success to warrant an increase in the line of credit. You must also have a good history with the lender.
How to Get Approved For a Line of Credit Increase
To receive approval from the lender, you will need to show that you are in a solid financial state. There are specific criteria for lenders to approve an increase, including:
- Revenue Growth: The ability to highlight your increase in revenue goes a long way. It highlights your business’ success and makes lenders more likely to finance your continued growth.
- Collateral: If you are requesting a significant increase, you may have to put up new collateral. Whether it is a more substantial accounts receivable fund or a larger inventory, these assets can help you secure funding.
- Business history: In addition to the above, lenders want to see a solid track record of operation. This means so lapses in operations and a consistent record of revenue.
How To Manage Your Business Line Of Credit
- Be Aware of Costs: To prudently manage your credit line, ensure that you are fully informed of all fees. Often, these include things like maintenance fees (usually paid out annually). However, there are other costs associated with certain credit lines. Check if there is a transaction fee, and govern your spending accordingly to minimize your costs.
- Request the Proper Amount: Responsible spending means not taking on more than you can handle. Identify the proper line of credit limit and create a reliable history with your lender. This way, should you need to increase the amount in the future, you are in a good position to do so.
- Making Payments: While minimum payments are acceptable, they do not bode well for your credit profile. Whenever possible, pay off more than the minimum amount. Aim to pay back the amount as soon as possible to remain reputable in the eyes of your lender. Though, especially due to the pandemic, late payments are a risk, strive to never encounter this situation. If the circumstances are beyond your control, contact your lender. Generally, there is a fee associated with late payments.
Final Thoughts
Business lines of credit are a common, and useful, way to finance short-term expenses. Finding the right lender may take time, but choosing correctly can give you an edge over your financial situation. Provided you use the funds responsibly, pay them back promptly, and don’t take more than you can handle, it is a helpful financial tool. If you own a business and are looking for a line of credit to help grow your business, Loans Canada can help.
