A revolving line of credit is a common type of small business loan. The lender sets a certain business cash advance of maximum funds and the business can use these funds as needed, only paying interest that accrues on the used funds.
How do business lines of credit work?
A line of credit works similar to a credit card. Businesses only pay interest on outstanding balances, which is usually on a monthly basis. When the principle is paid back, these monies are available for future borrowing.
What are business lines of credit used for?
This type of short-term credit is generally used to help finance ongoing working capital and when businesses need short-term cash flow. This may occur when receivables are late and operating expenses are due. Lines of credit are only used for financing short-term or even seasonal expenses.
Why do companies use these types of loans?
The single-most reason companies use lines of credit is that money is easily available at their disposal for short-term cash flow issues, last minute financing and seasonal purchases. Additionally, only that money that is borrowed accrues interest.
When should businesses avoid using lines of credit?
If businesses are looking for longer-term financing, they should avoid lines of credit, as they charge higher interest rates.
How do businesses obtain lines of credit?
Many lenders look at the business’ cash flow, wanting to ensure it is strong and they have enough receivables to make monthly line of credit payments. Additionally, other assets, such as real estate, inventory, etc., may also be taken into consideration when reviewing line of credit applications.
What amount should a business request?
A common question that most businesses have is, “What amount of a working capital loans or business line of credit should we request?” Generally, experts agree that the amount of loans depend on specific company plans, assets and financial needs. Generally, most use 75 to 80% of credit lines to help pay operating expenses, with the remaining amount available for emergency and contingency purposes. The business needs to have the necessary cash flow to pay down the balance to zero for a minimum of one month during each year. If the company cannot complete this financial task, it may be an indicator that they have borrowed too much against their line of credit or that sales are down.
When should companies apply for lines of credit?
Lines of credit are best for companies that experience seasonal or temporary cash flow fluctuations.