You know the value of a flexible tool like duct tape. It can fix, stick, bundle, or label whatever you need quickly and easily. A business line of credit is the duct tape of the financing world. It provides revolving access to funds you can draw from for surprise expenses, new opportunities, or managing a slow season.
A business line of credit is a flexible financial tool. But just like duct tape can’t fix everything, a credit line is not the right fit for every situation. When you understand its strengths and weaknesses, you can decide if it will meet your needs. Let’s see if a line of credit is useful for your business.
What Is a Business Line of Credit?
A business line of credit is a form of revolving credit, like a credit card. You’re approved for a maximum amount and can withdraw from it anytime. You only pay interest on the funds you use, not the full amount. Your available credit replenishes as you repay.
Lenders typically tailor terms and limits to business needs, making them a more competitive option than a credit card. You can use some business lines of credit indefinitely, while others have a draw period followed by a repayment term. You may have to wait 12 to 24 months before drawing on more funds in those cases.
You can draw from the line to cover any business need, like payroll, inventory, marketing campaigns, or equipment repairs. Say you run a flower shop and use $10,000 from your $40,000 credit line to stock up before Valentine’s Day. You pay interest on that $10,000, and have access to the full $40,000 again once you repay it.
Pros of a Business Line of Credit
Flexibility is the biggest advantage of a business line of credit, especially if your business expenses or cash flow vary from month to month, like in the food service industry.
Suppose you want to buy extra inventory for a holiday weekend. A line of credit will allow you to stock up now, or anytime you expect a larger crowd, quickly and flexibly. As you pay it down with the proceeds, you’ll have more money available to you for upcoming events or unexpected expenses. Which business expenses you use the money for are up to you.
A business line of credit also gives you control over costs. You only pay interest on what you use, avoiding the burden of paying interest on funds you didn’t need. Maybe you thought $15,000 would cover payroll, but you overestimated by $5,000. A term loan would charge interest on the full $15,000. With a line of credit, you only pay interest on the $10,000 used. This makes a line of credit a cost-effective solution.
Access is another major pro for business lines of credit. Once approved, the funds are available as long as you stay in good standing. Say the lawnmower in your landscaping business needs extra maintenance during the summer months. You won’t have to reapply for funding each time you take it to the repair shop with a revolving credit line. That availability is a lifeline when timing matters.
Cons of a Business Line of Credit
The variable interest rate of a business line of credit is a downside for this tool. Interest rates depend on your creditworthiness. If you consistently use a large portion of your available credit or only make minimum payments, you are a riskier investment for your lender. They may increase your interest rate to account for your credit habits, making your costs increase over time.
Some business capital lenders also charge fees that make business credit lines more expensive. Watch for annual maintenance fees, which charge you for not actively borrowing, or draw fees, which increase the cost every time you use the credit. It’s important to read the fine print and ask about all costs before you accept an offer.
A flexible credit line also requires financial discipline on your part. Because the funds are reusable, treating the credit line like a cash reserve can be tempting. But that will sink your business into debt. You need an investment strategy and repayment plan for the funds before you draw on your line of credit.
Business Line of Credit vs. Term Loan
To know whether a line of credit is right for you, it helps to compare it directly to another common financial tool: a term loan. A term loan provides a lump sum with a fixed repayment schedule. You receive the money once and repay the funds until the end of the term.
Term loans are ideal when you have a one-time, large expense and have time to plan for the investment. You know exactly what you’re borrowing, so they offer lower interest and predictable payments. Term business loans are a cost-effective option if you need $100,000 to purchase major equipment or expand to a second location.
Lines of credit, on the other hand, are best for businesses with ongoing or unpredictable expenses. You can draw on your credit as needed, save money on interest, repay early, and access the funds again. If you need $15,000 throughout the year for marketing, inventory, or short-term projects, a line of credit gives you more control and liquidity.
Qualifying for a Business Line of Credit
Getting a business line of credit depends on several factors. One is who provides your financing. Online lenders have faster approvals and more flexible requirements, while banks offer lower interest rates but stricter qualifications. You’re more likely to get approved if:
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- You’ve been in business for at least six months
- Your business generates steady monthly revenue
- You have a personal credit score above 600
All lenders typically look at your business’s financial health, revenue, credit history, and time in operation. Most applications will require you to submit basic documents related to those areas, such as:
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- Business bank statements from the last three to six months
- Personal and business tax returns
- Profit and loss statements or balance sheets
- A business license or EIN
One for the Toolbox
A business line of credit is a powerfully flexible tool. It can offer you freedom to seize new opportunities or peace of mind during emergencies. By understanding the pros, cons, and qualification criteria, you can better decide if a line of credit fits your business model. It’s not a fix-all, but it can be one of the most valuable options in your financial toolbox.
