Cash flow challenges can affect small businesses in any industry.
Invoice-based and seasonal companies are especially vulnerable to cash flow shortages because of their inconsistent revenue. Even restaurants and retail stores that are historically less prone to day-to-day income fluctuations were hit hard by COVID-19 restrictions.
So what can you do to prepare for cash flow difficulties with your business? In some cases, a line of credit could provide the solution.
How a Line of Credit Can Help with Cash Flow
No matter how carefully you budget and plan, unexpected events can still catch you off guard and put a strain on your cash flow. Having a ready source of income like a line of credit can serve as a safety net in the following situations:
- Delayed receivables — Your customers fail to pay for your goods and services on time.
- Underperforming sales — Revenue dips below what you expected, but you can’t put off expenses like payroll and mortgage payments.
- Large inventory purchases — You need to purchase more inventory than you anticipated. This can occur because of loss or a bulk discount opportunity or sale.
- Expense spikes — You have unexpected cost increases like utility bills that rise faster than you planned for or a company vehicle that breaks down and needs to be replaced.
You can adjust for these updated figures on future budgets; however, in the meantime, you may need other income to bridge the revenue gap.
With a bank line of credit, your business will have available funds that it can draw from as needed, up to your predetermined limit. This allows you to cover your expenses until you can recalibrate your finances.
As you pay back the borrowed funds, you also replenish the credit amount available for future draws.
Pros and Cons to Using Lines of Credit
A line of credit can be a useful cash flow tool, yet it’s not the best solution for every company.
- Low interest rates — Line of credit interest rates are often relatively low compared to other cash flow solutions like credit cards. You could have an APR in the single digits with a line of credit, but your specific rate will depend on your credit score.
- Flexibility — Use (and pay interest on) only the amount of funds that you need.
- Fast access to funds — Once your account is in place, you are pre-approved up to your credit limit and can access the funds instantaneously.
- Build your credit score — Traditional lenders report activity to the credit reporting agencies, so your timely payments will help bolster your business credit score.
Though you should also consider the cons to using a line of credit:
- Spending limit restrictions — Lines of credit generally work best for smaller cash infusions. Their relatively low spending limits may not be adequate to meet your company’s needs.
- Short-term solution — Make sure your future revenue will enable you to pay back what you’ve borrowed. Otherwise, the added debt may only serve to compound your cash flow challenges.
- Expensive fees — Although the interest rates are low, particular lines of credit are burdened with substantial hidden fees. Read the fine print and ask your lender for a detailed account of any potential charges.
- Possibility of overuse — The ease of use that makes a line of credit so attractive can also create a perilous situation. If you dip into your line of credit too often without a solid plan for paying it back, it may end up making more problems than it solves.
- High qualification requirements — A line of credit will be of no use if your business cannot qualify. Unfortunately, banks often establish steep requirements like a high FICO score and at least two years in business.
Alternative Cash Flow Solutions for Your Business
After weighing the pros and cons, you may decide that a line of credit is not the cash flow panacea you were expecting, or you may not quite qualify. What else can you do to ensure that enough working capital is available to cover your expenses?
- Build up cash reserves — Prepare for unexpected cash flow shortages by setting up reserve accounts with at least enough to cover three to six months’ worth of expenses.
- Reduce expenses — Negotiate with vendors, take advantage of free advertising channels like social media, and look for other ways to trim unnecessary outflows of cash.
- Increase sales — Work to boost your sales by soliciting customer reviews and feedback, offering a discount to repeat customers, and encouraging referrals and positive word of mouth.
- Shorten your accounts payable cycle — If your customers have 30 or even 60 days to pay their invoices, find ways to speed up their payments. Offer a discount for paying early or get the cash upfront through invoice factoring — selling unpaid customer invoices to a third party.
- Apply for the Revenued Business Card — The Revenued Business Card has many of the same benefits as a line of credit, including flexible funding at your fingertips and a set spending limit that you can use over and over again. You only pay for the funds you use, with no hidden fees. Best of all — you can qualify even with subprime credit and six months of business history.
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