Business Line of Credit

One of the most desired option for handling regular cash flow for any small business’s requirements has been a business line of credit. Line of Credit (LOC) is a specified amount of money that you can access as and when needed which have to be repaid immediately or over a pre-specified period of time.

LOCs are specifically designed to help businesses finance short-term working capital needs like –

• Purchasing inventory or repairing equipment
• Financing marketing campaigns
• Making payroll

There are two main types of business LOCs:

1. Secured Business Line of Credit: With this type of LOC, a business must pledge assets as collateral to secure the loan. Since a Line of Credit is a short-term liability, lenders will typically ask for short-term assets, such as accounts receivable and inventory. Lenders usually won’t require capital assets, such as real property or equipment, to secure an LOC. If the borrower is unable to repay the loan, the lender will assume the ownership of any collateral and liquidates them to pay off the balance.
2. Unsecured Business Line of Credit: This type of LOC does not require assets as collateral, thus is a more attractive option to business owners. Here the lack of collateral means a higher risk to lenders, so to get an unsecured LOC you’ll need stronger credit and a positive business track record. In addition, the interest rates are often slightly higher. Unsecured lines are usually smaller.

How does LOC Work

When you open a line of credit, you’ll receive permission to use a specified amount of funds as and when it is needed. You then receive a monthly invoice reflecting the amount of credit you’ve used, along with any interest charges.

Your payment is based on the actual interest accrued on these funds while you use them. Once the funds are repaid, that amount is available when you need it. You’re only charged interest on the amount of the loan you actually use.

LOC rates and limits are set by lenders and based on your risk grade, your collateral, and any servicing requirements. Here your risk grade is based on factors like the financial success of your business, the state of your business sector in general, your business and personal credit scores, and whether or not you have collateral.

Most lenders will charge an annual fee for the LOC, in addition to interest charges. If you’re going to need a significant number of loan advances and repayments, transaction fees might apply.

Is LOC really required?

If your business regularly requires funds to cover short-term cash flow issues, manage your business’ day-to-day needs, or take advantage of immediate business opportunities, then applying for an LOC makes sense.

Criteria to be met –

Any lender will want to see your business’ documents, including financial statements, tax returns, your resume and an explanation of your business history. The lender also will expect to see a three-year projection of business revenues and expenses, with an explanation of how and when the LOC would be used to support your cash flow. You might also be asked to provide detailed schedules of the company’ accounts receivable, inventory and all liabilities.

Lenders look critically at LOC applications to determine whether the company needs funding to cover growth opportunities. Lenders generally avoid providing funding to startups, for covering losses on past operations, or to meet immediate expenses that won’t necessarily lead to profits.

Make sure that your business displays that –

• It is a profitable operation that is capable of generating additional revenues.
• Management has command of the working capital cycle of the business, the repetitive process of when expenses like inventory and payroll have to be funded to produce products or services, and when the resulting revenues will be collected.
• The business has a plan for using the LOC to cover specific expenses at specific times, and knows when the resulting revenue collections will be used to make payments.

Tips on Keeping a Business LOC

• Periodically pay down your debt completely and avoid keeping your balance near your credit limit. This will keep your lender at ease.
• If your company is not profitable, using an LOC to cover losses is not the best option – you may have trouble acquiring the funds to repay it.
• The best time to set up a business line of credit is before your business needs it. Lenders are more likely to grant an LOC when your business’ cash flow is strong. It will also give you a financial cushion when you actually need the extra cash.

Conclusion

Business lines of credit offer financial flexibility to cover gaps in the normal business cash cycles, thus helping small businesses grow revenues and expand profits. They can be used to harness the necessary resources to maintain activity year-round and can fund expenses to develop your vision, build your organization, and amplify success.

CONVERT YOUR RENT TO EMI!