Line of business credit
A line of business credit is a viable option for business financing, especially when you need funds from time to time, but can't specify exactly what for. For example, a business line of credit could be used for purchasing equipment, but an equipment loan couldn't be used for day to day operating expenses. The business line of credit is a flexible option for financing. Let's take a look at what business owners should know, and consider about business lines of credit BEFORE applying for or obtaining one:
1. A line of credit (LOC) is usually considered a short-term loan. This means that you need to pay it within a year. Of course, because a line of credit is a revolving credit, as long as it remains in good standing, typically it will remain open for longer than a year.
2. Payments are different from traditional loans. The payments are interest-only, based on the outstanding funds in use. Thus, if you get a line of credit for $50,000, but only use $5,000 of it, the payment amount would be the interest on the $5,000. This is paid monthly, just like a traditional loan. It is important to note that as you draw down on the line, using it to pay bills, interest is accrued monthly. Thus, your payment amount will change, going up or down, each month based on how much you owe.
3. You can use it in many ways. Unless the lender specifies otherwise, the line is like an open checkbook for ‘use as needed' purposes. In other words, it is left to the business owner's discretion to use the funds as they see fit. This can be for any number of things, from overhead expenses to purchasing inventory, or even paying employees.
4. Be careful to pay down the balance. The trick with a business line of credit is that as you use funds from it to pay bills and the like, that you replace the funds when your customers pay you for goods and services. A line of credit can be a great way to bridge the gap between when you invoice a customer and when they pay you, but can get you in trouble if there is not a constant flow of money is as well as out.
5. Lenders typically want to see specific things from borrowers who are applying for a LOC. They want to see historical cash flow. They will ask questions like What does the revenue look like? Is it steady, or does it fluctuate a lot? What kind of A/R's are there currently? Most banks will take a conservative view, and only give lines of credit to existing businesses with a strong financial history, and cash flow history. In other words, they want to make sure that you have the funds coming in to cover the interest and replenish the line.