Whether a small business is just getting started or has been in operation for a while, cash in hand is a critical factor that determines business success. Many small business owners require a steady flow of income for growth and expansion. Some owners turn to cash savings, seek investors, or go for a business line of credit.
Entering into a business line of credit for the first time can be time-consuming. However, once the business line of credit is functional, the business starts to develop and earn its own credit profile. Small businesses have to build a credit history to get future credit accounts and loans. Using a line of credit enables one to build a positive business credit history as they use the line and make the payments on time.
How a Business Line of Credit Works
Just like a credit card, a business line of credit can be acquired in any amount as long as it meets the pre-determined credit limit, which one accrues interest on the amount they had withdrawn.
This is what differentiates a business line of credit from a business credit card. As a borrower, one receives the cash to cover costs that couldn’t otherwise be purchased with a credit card.
For a business line of credit, one receives a maximum balance and takes money from that balance when they need it. Each month, one makes a minimum payment according to the current balance of the loan. By contrast, business loans function like a mortgage or car loan. A bank lends you a one-time amount and you make regular monthly payments until it’s paid off.
Business Line of Credit: Pros
Business lines of credit are popular because they can bring valuable advantages to your business. They include:
- The Balance Cash Flow
Designed to provide working capital, business lines of credit are the ideal tool for balancing the cash flow. They let businesses pay bills and expenses on time, enabling one to make use of automatic payment discounts. Seasonal businesses can get the most out of a line of credit as the cash influx from peak times isn’t quite enough to make it through the off-peak months. Businesses can access the line of credit and pay it down when the clients return.
- Pay for What You Need
A business loan gives one a lump sum according to what they think is required for the business. If one guesses lower, then one has no choice but to seek extra capital elsewhere. Quick credit, in this case, tends to be expensive and time-consuming to obtain.If one demands a higher amount, they will have to live with paying the higher interest and initiation fees on the money they didn’t have to borrow. The entire investment becomes less efficient and can become really dangerous if the loan has early payoff fees.As for a line of credit, one only pays interest based on the amount they use. Depending on the agreement with your lender, one may be able to pay off the balance at any time without a prepayment penalty.
- Improve Business Adaptability
Sometimes a business can have a limited window to seize opportunities. One might have an opportunity to advertise, participate in an event or a supplier’s cost has been significantly reduced. Business owners can take advantage of that limited offer when they don’t have the cash to do it. With a business line of credit loan, one won’t risk missing out on a great opportunity to save money in the long run.
- Build Business Credit
Business credit lines help build a business credit history. To get the best terms by avoiding higher interest rates on personal loans, one needs long personal credit history. If businesses would like to boost or maintain their credit score, receiving a business line of credit and paying it off quickly is a great way to achieve this.
Business Line of Credit: Cons
Just like any capital source out there, a business line of credit also has its downsides. Without assessing potential issues that could arise after receiving the lines of credit, sometimes one isn’t properly prepared to entirely make use of this financing option. Here are the cons you would expect with a business line of credit:
- Extra Charges and Fees
Even though they are not as expensive as business credit, business lines of credit have high-interest rates. Fees and charges quickly add up as most of them carry hidden initiation, processing, and maintenance fees. It is important to conduct proper research and compare online lenders’ annual fees and other additional costs to find a suitable line of credit for your business or figure out if another financing product is more affordable.
- Time-Consuming Application
Apply for a legitimate business line of credit demands one to provide:
- Business bank statements
- Personal bank statements
- Personal tax returns
- Business tax returns
- Recent profit and loss (P&L) statements
- Business documents (such as articles of incorporation)
- Resumes for leadership
It is a long and complicated process that demands one to apply for a secured installment loan or credit card.
- Can Lead To Temptation
Even though a business line of credit helps you grab opportunities, some opportunities turn out to disappoint. If your business borrows too much, it can be a recipe for disaster.
Having already acquired significant debt, or not being significantly confident that it’ll be able to repay the balance, it might not be the right time for one to take on a line of credit. It is easy to borrow excessively against your business line of credit and spend the profits on investment payments.
- Low Limits
Sometimes business lines of credit have limits higher than a credit card but lower than an installment loan. If the line has a lower limit than your needs, it’s not a worthy solution. It just sets one up to accumulate debt without reaching business goals.
Every business is unique and has its own unique situations. However, as business owners take up debt, they should ensure the decision they make to obtain a line of credit is done carefully.