Business Line of Credit: When a Loan Doesn’t Fit the Bill
You may have heard of a business line of credit and wondered why you’d ever need one. After all, your business is doing well and there is plenty of cash to pay the expenses. You don’t need a loan, right?
The truth is it’s not that simple. Business lines of credit have multiple uses beyond being a source of funds for business owners to pay for large capital expenses. From cash flow flexibility to being an alternative to expensive cash reserves, business lines of credit can come in handy for any small business owner. Read on below to find out how!
If you’re not familiar with this financial product, a business line of credit is revolving credit used by businesses of any size. Similar to a credit card, lines of credit allow businesses to borrow as little or as much as they need up to their credit limit whenever they need it.
Unlike a loan, which is usually provided by the lender in a lump sum, a credit line starts with the borrower owing nothing. The business owner withdraws only as many funds as they need and pays only on the portion they actually use. A loan, on the other hand, requires monthly payments with interest on the entire amount of unpaid principal.
Having access to a revolving source of credit like a business credit line can be tremendously valuable to small business owners in a number of ways.
A credit line serves as a line of defense against the unknown. While you could keep a large cash reserve as insurance against future emergencies, holding large amounts of cash can be expensive in terms of foregone investments and investments in the business. By using a credit line, you can respond to emergencies while reducing the amount of cash sitting idle in your savings account.
Keep in mind that you should not rely solely on the credit line in the event of an emergency. It is always wise to have some cash on hand in case something unexpected happens. What’s great about a business line of credit is that it allows you to reduce that amount without eliminating it entirely.
Cash Flow Flexibility
Every small business has regular expenses. Some have very large regular expenses. And some have significant business expenses that don’t sync up with income. In other words, expenses come due before the income needed to pay them has been realized.
In these situations, a business owner has two choices. They can keep a large amount of cash on hand to act as a “float” or they can utilize a business line of credit to pay expenses in advance of the receipt of income. In the former, the business owner incurs the costs associated with keeping cash on hand – lost investment and business revenue. In the latter, the business is free to reduce the amount of cash on hand, increase revenue, and still maintain the ability to pay expenses as they come in.
It’s always a good idea to keep cash on hand, just in case. A business line of credit should only be used to intelligently reduce that amount, not eliminate it entirely.
Why Not a Loan?
You may be asking yourself, “If I need an injection of funds why not just take a business loan? Isn’t that simpler?” Well, as mentioned earlier, a term loan isn’t a good fit for all situations. They certainly have their place. A one-time infusion or working capital to assist you in realizing revenue at a rate greater than interest rates on a loan are excellent opportunities to borrow. But you may notice that emergency reserve and cash flow flexibility don’t fit neatly into that category.
For situations when expenses are uncertain (as is the case with an emergency), a line of credit is the better option than a business loan because of the way the borrowing is structured. With a loan, one pays interest immediately on the lump sum of the borrowed principal. With a business line of credit, nothing is borrowed immediately and, therefore, no interest or payment is immediately due.
Only when the emergency happens and borrowing becomes necessary is the business owner required to make interest or fee payments. Even then, the interest or fees is calculated only on the amount borrowed rather than on the limit of the credit line.
The situation is similar for those who seek increased cash flow flexibility. These business owners do not need a large amount of money all at once but they require the ability to withdraw smaller amounts at regular intervals to make up for uneven cash flow. There is no need for these folks to pay a large amount of interest on a large loan when they could pay a much smaller amount for a shorter period of time by utilizing a credit line.
Some people consider debt to be a dirty word. They shouldn’t. Properly structured borrowing suited to a business owner’s circumstances unlocks opportunities that wouldn’t otherwise be available. Matching a low-cost credit line solution to a business seeking additional flexibility or protection against the unknown can result in significant efficiency gains. Business owners who take advantage of this opportunity find it easier and simpler to conduct their daily affairs.
Are you a small business owner who wants to increase their ability to respond to cash flow timing issues or unexpected emergencies? Fill out our simple, no-obligation, 2-minute application, give us a call or send us an email at Financing Solutions. We offer business lines of credit without any setup or maintenance fees that typically require no collateral or personal guarantees. Every business should have a line of credit, just in case.