Having several different financial resources to choose from is helpful when expanding your business. Flexibility allows your company to adapt to change, especially during periods of uneven cash flow or growth.
A business line of credit is an essential financial tool for many entrepreneurs. However, you need to be sure you can manage it. If a line of credit is helping your business thrive, and you can pay down the balance in a reasonable timeline, then applying for one would be prudent. Yet if you cannot manage your business credit line and interest and fees interfere with cash flow, you may want to reconsider.
Let’s take a look at how to manage a business line of credit.
What Is a Business Line of Credit?
A business line of credit is a small-business loan that works like a credit card and gives you the flexibility that typical business loans do not.
You can draw a loan amount — for example, $80,000 — and pay interest only on the part of the money you use. They are revolving lines of credit, and this means you can tap into them repeatedly. As long as you do not go over your limit, you can draw and pay back funds as you like.
Business credit lines usually have a higher borrowing amount than a personal line of credit, typically ranging from $5,000 to $150,000.
Use a Business Line of Credit to Manage Operational Expenses
Many business owners open a business line of credit to access short-term funding. A line of credit makes sense if you need to:
- Cover a surprise expense
- Support payroll
- Buy inventory
- Keep your cash flow in line
Cyclical businesses frequently depend on unsecured credit lines as a source of working capital to shore up revenue dips during the off-season.
Small business lines of credit are usually extended as an unsecured debt. This means you do not have to put up assets to be used as collateral if you default on the debt.
Companies looking for better ways to manage cash flow may choose an unsecured line of credit because, unlike many small business loans, they are not earmarked for a particular purchase or purpose. Money is usually pulled from the line using a small business credit card, a business checking account, or a mobile app.
Use Your Business Line of Credit Wisely
You can usually begin using your line of credit right away once you are approved. However, be sure to monitor how much credit you are utilizing and how much you are paying back.
If you only cover the monthly minimum payment, the interest keeps growing and can quickly mushroom out of control. You may find yourself at a point where it is impossible to pay off your outstanding balance.
Beware of Fees
Business owners often focus on the interest attached to the business line of credit but forget about fees. These extra charges increase the total cost of the loan. Contingent on the kind of credit line you have, you could also face:
- Prepayment fees
- Administration fees
- Annual fees
- Loan origination fees
On top of those fees, you have your interest rate. This is the percentage you will have to pay for the loan calculated based on your credit score. If your score is excellent, lenders may be more likely to view you as a reliable borrower and will be more at ease lending you a higher dollar amount at a lower rate.
If your score is lower you can expect to pay higher interest. Depending on the lender, interest rates usually range between a few percent to 20% or more. Interest rates are also controlled by the Federal Reserve, which sets the fed funds rate. Borrowing costs rise as the fed funds rate climbs.
Managing Your Business Line of Credit
Managing your outstanding balance is vital once you are consistently using your credit line. Monitoring your balance will keep your borrowing costs at bay and ensure you have funds available to draw on. Here are tips for managing your business line of credit:
- Plan for how you are going to utilize your funds and then stick to that plan. This will prevent your balance from becoming oversized. Included in your plan should be exactly how you will pay down the debt when you have the money to pay it down.
- Avoid buying long-term assets like equipment with your line of credit — use leasing or long-term financing instead.
- Draw on your business credit line when you have the opportunity for vendor trade credit discounts. Then when you have the cash, pay down your line of credit.
- Typically, lenders favor businesses that allow their credit lines to fluctuate with their needs and then rest a few times a year. You can save interest and show lenders you can manage your business line of credit with discipline if you pay your balance off several times a year.
By using your business line of credit for your company’s working capital requirements, your firm will profit by having a strong relationship with your lender and uninterrupted credit. This will allow you to increase your borrowing power to grow your company.
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