How Does a Short-Term Line of Credit Work?
A line of credit provides your business with access to funds that can be used for both routine and unexpected expenditures. Unlike a traditional bank loan, you don’t need to specify how you’ll use the line of credit to be approved. Instead, a business line of credit operates more like a credit card – you’re given a fixed amount of credit that is available when you need it, and you can repay borrowed funds all at once or in periodic installments.
Short-term lines of credit have many advantages, but they’re not right for everyone. Before determining the best short-term financing solution for your business, consider a few key questions.
Is a Short-Term Line of Credit Right for Your Business?
1. How Do You Plan to Use the Funds?
Business lines of credit are designed to help you meet your short-term working capital needs, such as payroll, inventory purchases, or equipment repairs. A line of credit can also be used to address emergency expenses or take advantage of strategic business opportunities when you don’t have the necessary cash available. If you regularly experience fluctuations in cash flow and require additional funds on-demand to cover expenses, a business line of credit can be a great option.
On the other hand, if you’re seeking capital to expand your business or make a large purchase, a line of credit probably isn’t the best solution. Interest rates on lines of credit tend to be higher than traditional loans, which can make large outlays difficult and expensive to pay back.
2. How Quickly Can You Repay Borrowed Funds?
If you’re applying for a revolving line of credit, repayment terms will typically be more flexible than with a traditional loan. While you’ll need to meet the minimum monthly payments, you can pay more or less each month depending on your business’s cash levels.
Additionally, interest rates on business lines of credit typically follow the prime lending rate, so your interest rate may fluctuate over time. Since interest starts to accrue as soon as you use your line of credit, it’s advantageous to repay your balance quickly. If you need more than a year to repay borrowed funds, a business loan may be more cost-effective.
3. How Strong is Your Credit History?
Short-term lines of credit can be easier to obtain than traditional business loans. Still, most lenders will only consider established businesses that have at least two years of operating history and a proven track record of growing revenues and profits. If your business is still in the start-up phase, alternative sources of funding may be more appropriate.
However, if you’re an established business but your credit history is weak, a line of credit can be a great way to build your credit score. By keeping a low balance and making your payments on time, you can establish yourself as a reliable borrower, making it easier to secure funding from lenders and investors in the future.
Like any source of financing, short-term lines of credit have their advantages and limitations, and only you know what’s best for your business. If you operate in a seasonal industry or simply need help meeting routine expenses, a line of credit can make it easier to manage your cash flow. By staying within your borrowing limits and repaying your balance quickly, you can build a strong credit history and increase your likelihood of obtaining more significant sources of capital down the road.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.