It can be tough to keep your business afloat in the face of seasonal fluctuations and other factors out of control. A line of credit means you always have something in hand that will help keep things afloat during those leaner months when revenue just isn’t coming through like expected. The best thing about these business lines of credit is they’re super popular with entrepreneurs because they give you access not only to physical assets such as inventory but also psychological ones – knowing you’ll never actually run out!
How does a business line of credit work?
Business line of credit is based on working capital, which is a measurement of your company’s financial health that considers both current assets and liabilities. Current Assets minus Current Liabilities equals Working Capital, or the amount you have available for use in short-term liquidity, such as making payments on accounts receivable and inventory or paying off expenses within a year from when they were incurred. Your working capital provides creditors with an accurate idea on how much money you spend regularly and whether these expenses can grow without incurring short-term debt that they might eventually owe back.
The flexibility of a business line credit is similar to that found in personal loans, with fewer limits on how you can use it and an available revolving period when payments are made. In addition, unlike personal loan agreements where interest-only periods may exist (which have higher monthly payment costs), there will always be some form or fixed overhead expenses covered by the principal balance. That makes these types easier for companies who need coverage against fluctuating day-to -day operating costs such as new accounts receivable creation and inventory shift purchases between products/services offerings.
How do I qualify for a business line of credit?
In order to meet minimum requirements and get approved by lenders, who typically ask for information such as this, you should be prepared to produce the following:
- The last three fiscal year-end, CPA-prepared financial statements
- Your last two interim financial statements
- The last three months’ accounts receivable, accounts payable, and inventory aging reports
- Your most recent corporate tax returns
- Guarantor personal financial statements and tax returns
In addition, here are some typical minimum financial metrics you may have to meet:
- Being in business for at least five years
- Meeting most of the underwriting guideline parameters for the line of credit structure required by the bank
- Being in a consistent asset conversion cycle
- Having good guarantor and senior management experience
The above minimums are not all-encompassing. As with any line of credit, there is a significant amount of dialogue involved between the lender and the borrower during the assessment. However, if you meet these requirements, your chances of getting approved will be notably higher.
Best Practices for a Business Line of Credit
Open a LOC before it’s needed. A business lines of credit with the lowest possible interest rates or backed by the Small Business Administration can take longer than expected for the application and approval processes. Take the time to plan ahead if you are looking for a business line of credit – It’s smart to apply for one long before it’s needed, so cash flow isn’t interrupted.
Limit how often it is used. It’s important to match a purchase with the right type of funding and while an open LOC might be convenient, it shouldn’t be overused. LOCs are intended for short-term loans lasting just a few days or weeks—not years. For a big-ticket purchase or extremely large cash advance, a different type of funding is often more cost effective.
Pay it quickly and leave it open. Similar to a credit card but less expensive, a business LOC is not intended to carry a balance for any length of time. They’re best used for short-term funding that can be paid off quickly, allowing the LOC to remain open most of the time for emergency use. A business can’t use it to manage cash flow if it’s never available.
Adjust the monthly payment based on cash flow needs. To keep more cash on hand, a business should make smaller payments during the off-season or slow month and larger ones when revenue is flowing. This will avoid dipping below the minimum payment requirement which ensures that you’ve got enough money available for what matters most.
Avoid using it for ongoing operational expenses. While it may seem like a good idea at first, using your line of credit for operational expenses instead of one-time items can actually end up costing more in the long run and will likely leave the credit line continually maxed out and carrying a big balance.
Is a Business Line of Credit right for me?
A business line of credit can be a lifesaver for your company. You’ll have access to cash when you need it most and seasonal fluctuations won’t drain resources from operations like they used too. A business line of credit simplifies your life because it’s a revolving form of credit. Instead of borrowing a lump sum of money from the lender, you get access to a set amount of money that you can dip into, repay, and access again.
It’s important to ask questions and compare options when you’re in the market for new credit. Make sure that your funding manager knows what’s most valuable so they can help guide decisions about which type of financing is right for you.