In your personal life, you don’t always have the cash on hand to buy the things you need. Large, important purchases, like homes, cars, and furniture are almost always financed through loans, and even everyday shopping can go through credit. People need personal lines of credit to afford those items that help them live better ― and the same is true of businesses. Regardless of your business’s level of success, you should consider applying for a line of credit, and here’s why.
What Is a Business Line of Credit?
Typically arranged between a business and a bank ― or another stable financial institution ― a small business line of credit is a financial tool that establishes a loan balance from which the business can withdraw funds. Much like a personal credit card, the lender establishes a maximum amount, which the business cannot exceed. Every month, used credit accrues interest, and the business must make a minimum payment to the lender to avoid penalties.
There are dozens of ways for businesses to acquire cash, including other types of business loans. However, lines of credit differ because they are recurring, they are smaller and cheaper, and most importantly, they are controlled almost entirely by the business itself. Business leaders decide when and how much to borrow, when and how to use that cash, and how soon they will pay it back. As a result, lines of credit are more flexible to a small business’s typical needs, making them a must-have for healthy small-business finances.
The 4 Uses for Lines of Credit
That isn’t to say that lines of credit should be used for all a small business’s needs. For example, startup costs tend to significant, and few lines of credit will cover such sizable amounts. When you need quite a lot of cash and you aren’t sure when you can repay it, you should consider other financing options, like traditional loans, investors, or crowdfunding. However, once your business is up and running, you will probably need a line of credit to ensure it continues to run smoothly. Likely, you will find a reason to acquire a line of credit in the following four expense categories.
B2Bs and other businesses that tend to wait between project completion and payment often endure periods without much cash on hand. When your business gets tied up by its accounts receivable, you still need money to keep the lights on and the coffee flowing. By drawing down on a line of credit (the industry phrase for withdrawing funds), you can get the cash to keep your business running until clients pay their invoices.
Usually, working capital lines of credit are one-year terms with floating interest rates, and many lenders will limit your max credit to 70 percent of your accounts receivable.
Providing less flexibility than other lines of credit, asset acquisition lines (also called asset purchase lines) are used only when you need to buy new equipment, land, or other assets. When you desperately need another bay of computers or wall of ovens, you send the invoices for your purchases to your lender, who will then pay roughly 70 percent of the costs to help your business obtain the assets you need.
Asset acquisition lines of credit mature, unlike other lines of credit, meaning once it expires, businesses can no longer draw down on it. Then, payments convert to principal and interest amortized over a fixed period, usually between three and seven years. These lines of credit usually have fixed interest rates, making them more manageable.
Construction and Expansion
Large-scale construction efforts ― like the building of a skyscraper or a housing development ― require large construction loans, but if your small business needs renovations or you have some other small-scale construction need, you can use a business line of credit. For example, refinishing a retail space to create a restaurant or combining separate office spaces into one are excellent uses for a line of credit.
One drawback of using a line of credit for construction and expansion efforts is that you will need to pay costs out-of-pocket initially. As with asset purchase lines, construction lines will repay you using the invoices you submit. Sometimes, lenders will visit construction sites to survey the work ― ascertaining that invoices are correct.
One of the least common types of business lines of credit, guidance lines offer a business speed and flexibility. Essentially, a guidance line requires a lender to give pre-approval on future purchases. You might require a guidance line if you don’t need anything yet, but when you do have a need, you must act swiftly ― like a real estate company looking for properties to flip.The terms of guidance lines vary depending on what businesses expect to acquir
e with them. Usually, the loans are relatively sizeable and are repaid over a decade or more with an adjustable interest rate. Guidance lines mature after one year, but businesses can choose to renew the line as necessary.