Business line of credit (everything you need to know about Business Line Of Credit)

You might be wondering what business line credits are, look no further we’ve done the research on this article we will see what business credit lines are and as well as their pros and cons.

What is a business line of credit?

A line of credit is a predetermined amount of funds that you can borrow from when you need to and pay back later. Unlike, a traditional term loan, you can use the funds as and when you need them for business purchases like inventory, supplies, or operating expenses. A critical difference between lines of credit and term loans is that lines of credit are “revolving.” That means you can use the funds, up to your approved amount, then repay what you’ve used to make the funds available again. Term loans, on the other hand, are lump sum loans that you use once and repay once, with interest.

How you could benefit from a business line of credit:

All businesses need access to funds to run their operations, but sometimes there isn’t quite enough working capital available when you need it. You might be waiting for your Favorite big client to pay their invoice, or you might need to purchase an expensive new piece of equipment. Situations like these may seriously affect your cash flow and even threaten the stability of your business. 

If you’ve got a line of credit in place, however, you can handle these challenges with confidence, knowing you have access to the capital you’ll need. Businesses commonly use their business line of credit as a tool to optimize cash flow and take advantage of new opportunities

For example, a credit line can come in handy for things like:

•        Hiring new employees to meet a growing demand for your services.
•        Covering payroll.
•        Opening a new office or expanding to a new location.
•      Purchasing inventory to get ready for a busy holiday season.
•     Running marketing campaigns. 

A business line of credit can help you run your business with less stress since you will have access to funds when you need them most. A credit line is revolving and simple to use especially if you're used to business credit cards. Only pay for what you use. Once you receive your funds, you can repay to replenish your available credit limit, then draw again when you need it.

 

Business lines of credit fall into two main categories: secured lines and unsecured lines.

Here are some crucial differences between the two types:

·       Secured business line of credit: With a secured business line of credit, the lender asks the borrower to pledge their assets against the loan as collateral. Since this is a temporary liability, the lender may accept inventory or accounts receivable as collateral. They probably will not ask for significant assets like equipment or real estate. If the business fails to pay off the business line of credit loan, the lender can take the collateral.

·         Unsecured business line of credit: Most business owners looking to get a line of credit prefer this option because the lender does not require any assets as collateral. Lending funds without holding collateral is riskier for the lender, which means that there is typically a higher bar to meet to have a chance of getting approved. To get approved, you will probably need to prove that you have good personal credit, good business credit, and a track record of generating revenue. Unsecured business lines of credit are often given for lower limits and at higher interest rates.

Understanding the pros and cons

Pros of getting a line of credit

Flexible access: One of the primary benefits of a business line of credit is its flexibility. Once approved for a business line of credit, you can draw funds when you need them, and use them for whatever legitimate business purpose you want. Unlike a term loan, funds from a line of credit are revolving, meaning that when you pay them back, you can use the funds again.

·         Interest only on the portion of credit you use (sort of): An important benefit is that with a business line of credit, you aren’t charged interest on the unused portion of the funds, only the part you use (plus fees, depending on the situation). For example, if you have $60,000 and you use only $20,000, you will only have to pay interest on the $20,000 used. This contrasts with a term loan, where you are charged interest on the full lump sum. 

·         Lender-borrower relationship: Cultivating a good relationship with a lender can be extremely beneficial later on. If you develop a good relationship with your lender through the responsible use of credit, this can lead to help from your lender if you need a credit increase or further finances for projects in the future.

·         Better business credit rating: If your lender reports back to the credit bureaus, using your line of credit carefully and repaying on time can be an excellent way to build credit. This can benefit you by raising the credit rating of your business. This can help you in the future if you ever need more credit or a term loan. 

·         Lower interest and lower fees: For some business expenses and situations, it’s often better to use a business line of credit than a business credit card, because business lines of credit typically have lower interest rates than business credit cards. A business line of credit operates like a credit card as explained above, with a revolving balance, but they tend to offer lower interest rates, and there are no fixed payments. 

This last “pro” comes with a few big caveats. There are lines of credit that are just as expensive as credit cards, if not more so. Even if a line of credit does not come with prepayment fees, they might front-load the fees, so you do not save as much by prepaying. If you are hunting for lower costs, it’s always wise to compare your options carefully before deciding. 

Cons of getting a line of credit from a big bank.

·      The application process can be complicated: While it’s not always the case, applying for a business line of credit from a major bank can be a slow, challenging process. It will most likely involve providing the lender comprehensive financial statements and revenue reports, including cash flow statements, tax returns, as well as your personal credit history and personal information. 

·       Fees add up: Even though a credit card often has higher interest rates than most business lines of credit, a business line of credit loan might lead to hefty withdrawal and maintenance fees. You may want to try to negotiate a low rate of interest to account for such fees. You should at least be aware of them so you can avoid as many fees as possible.

·      Too much debt: One big challenge to keep in mind is accumulating debt. If you are unable to pay back the funds owed, you could find yourself in default with your lender. It’s easy to get into a debt spiral, so it's important to stay on top of your payments. If you can’t make your full payment, the interest compounds on the new principal amount. That means, one missed payment can lead to larger and larger payments in the future. This can go on indefinitely and is a situation that you will want to avoid. 

What are the requirements to get a business line of credit?

To get approved for a business line of credit from a bank, you’ll need to complete a thorough application process. 

Here are some common requirements for getting a new business line of credit from a major lender.

·         Collateral: As we discussed above, a secured business line of credit is safeguarded by collateral which you provide. This may include (but is not limited to): real estate equity, physical inventory, equipment, or accounts receivable. Your business guarantees the loan with that collateral, reducing the risk for the lender. Sometimes a lender will tell a small business owner to pledge all of their assets to secure a business line of credit.

·         Business operating time: Most lenders will have a requirement that a business be in operation for a certain length of time before qualifying for a line of credit. Some lenders (such as major banks) may only consider businesses that have been in operation for at least two years. If the lender feels a startup has good collateral and sound personal credit, it may make a rare exception. Time in business requirements may differ from lender to lender, so be sure to ask.

·         Financial statements and reports: According to the US Small Business Administration and reported in USA Today, only 20 percent of new businesses survive past their first year of operation. That’s one reason why most banks require extensive financial statements along with income tax returns spanning at least two years to consider your business for a line of credit.

·         Profit and revenue: Your business should generate revenue to be eligible for a business line of credit. When you apply, chances are you will be asked to provide proof of revenue and business health. In cases where there is not enough income or profit to satisfy the lender, the business may have an option to provide collateral in case of default.

·         Guarantee: If your business is a subsidiary of a big organization, the lender may need the parent organization to give a guarantee for your subsidiary before it gives a business line of credit to the subsidiary. If you’re an independent small business owner, you may need to make a personal guarantee.

·         Economic ratios: By cross-checking certain important economic ratios of your business, the lender can estimate your business performance. These ratios may include:

Conclusion:

Here are a few conclusion facts about business credit lines, depending on the angle you'd like to take:

Positive:

• Business credit lines are a valuable tool for growing businesses to manage cash flow, cover unexpected expenses, and seize opportunities. They provide flexibility and financial security, aiding in long-term success.

Neutral:

• Business credit lines come with responsibility. Interest rates and fees can add up, so responsible management and timely repayments are crucial to avoid financial strain.

Negative:

• Overreliance on credit lines can be risky. It's essential to only borrow what you can realistically afford to repay, as excessive debt can hinder your business's financial health.

 

We hope this helps your knowledge about business credit lines.