When Should You Apply for a Line of Credit?
The primary benefit to using revolving credit is quick access to cash without collateral, which gives entrepreneurs more flexibility in their business spending. When used correctly, a line of credit can be an excellent tool for managing cash flow. Here a few situations in which your small business may benefit from receiving one.
If You Don’t Want a Credit Card
Lines of credit operate similarly to business credit cards. The lender will allow you to borrow up to a limit based on your creditworthiness, and charge interest only when you carry a balance. However, carrying a credit card balance is one of the most expensive financing methods. Interest charges can often outweigh marginal benefits like points or rewards. A business line of credit will typically allow a larger cash advance, and much lower interest rates.
If You Need to Float Accounts Receivables
In a perfect world, customers would pay on time, or in advance, and money invested immediately becomes money made. Unfortunately, business owners must pay staff and suppliers even if customers are late paying their bills. Lines of credit are useful to cover temporary lapses in cash flow, so your business can keep running.
If You Go Over-Budget
Access to revolving credit may also come in handy if expenses on a project exceeds original estimates. It would be impractical to stop a project you are midway through to secure additional funding. A line of credit could help get the project to completion, so the proceeds to cover the expense.
If You Don’t Have Collateral for a Loan
Occasionally, entrepreneurs may have a large business expense that cannot be backed with collateral such as equipment or real estate. For example, a marketing campaign. While the benefits may be material, their intangible nature may make it hard to secure a loan because the lender has nothing to seize if the investment fails and you default. A revolving line of credit allows business owners to make decisions for growth that may be hard to sell to others within the rigid structure of term loan applications.
If You Need to Build Credit
Credit can be hard to come by for small businesses without lengthy operating history. Banks often want to see strong financial records, and proof of longevity. After all, the lender wants a reasonable expectation that the business will pay back what it owes. Responsible long-term use of a revolving line of credit can make your business a more attractive borrower in the future when applying for a loan.
If You Take on Big Orders
Having a business line of credit gives small business owners the flexibility to take advantage of opportunities as they arise. For example, a retail business with steady sales may be presented with a blockbuster order they would not be able to fill without more material and labor than they can afford with existing cash flow. Having a line of revolving credit means small business owners have access to cash so that they can take on projects that they wouldn’t be able to afford otherwise.
If You Have Seasonal Expenses
For seasonal businesses that make most of their revenues within a small period, it doesn’t make sense to take out a term loan that will require consistent payments throughout the year. One benefit to revolving credit is that you only accrue interest on the amount you have outstanding. You can use a line of credit to fund temporary expenses, like material or labor, and pay it back when the product sells. Note that some lines of credit require a monthly or annual maintenance fee even when you are not using it.
Revolving lines of credit are useful because they offer a cheaper and more flexible options for funding than bank loans, credit cards, or investors. However, knowing when to use them can help small business owners maximize their profitability, fund growth, and build credit for future borrowing.
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.