September 4, 2023
One of the greatest assurances as a business owner is the knowledge that you can access funding whenever you need it.
It’s even more exciting to know that multiple business financing options are at your disposal, regardless of your company’s scale or location. You could opt for traditional loans or explore other less conventional mechanisms like a line of credit.
This article explains what a line of credit is and the five ways you can use it to spur business growth.
A line of credit, also known as a bank operating loan, is a short-term, flexible loan in which a borrower can repeatedly withdraw from a preset amount.
Most lines of credit are advanced by mainstream financial institutions, such as commercial banks and micro-financing companies. The facilities are typically advanced to small businesses, although multinationals can also be eligible. In fact, governments, state corporations, and individual customers may also constitute a line of credit borrowers.
Having an arrangement with a line of credit lender lets you draw from the allocated facility whenever you need funds. You can withdraw as frequently as possible until you deplete your allocation.
The only major challenge for many borrowers is finding the best business line of credit. Fortunately, there are various aspects to consider when searching for a suitable lender. Those include the borrowing limit, repayment period, and any associated fees.
Lines of credit and conventional business loans serve the same purpose of availing funds to cash-strapped companies. However, the two concepts have certain fundamental differences.
Notably, a traditional business loan advances a lump sum amount simultaneously. Borrowers must repay the principal plus interest within a preset frequency (typically monthly) and duration (1 month to 10 years or over).
In comparison, a line of credit functions more like a credit card. Your lender presets the credit limit you can borrow as often as needed. Amounts can range from as little as $1,000 to over $100,000.
Unlike regular loans, where you receive the advanced lump sum at once, a line of credit makes the requested amount accessible (if you qualify), but you don’t actually have to use all the funds at once. You can draw portions of it and only repay the used amounts. Besides, you can spread your usage over time (ranging from days to years).
Another fundamental difference between a line of credit and a regular loan relates to the lenders. Lines of credit are almost always advanced by mainstream financial institutions, while some business loans can be availed by informal entities, such as friends and relatives.
One of the classic use cases of a business line of credit is to supplement capital-intensive projects.
Assume that you’ve recently expanded to a new location and have purchased a new office building. However, the amount you previously allocated to the expansion project suddenly runs out before you can procure all essential office supplies.
It makes little economic sense to leave such an ambitious project three-quarters done. As such, you may draw from your line of credit to complete the set-up process.
There will be times when your accounts payables are higher than your revenue stream can offset at once. In such instances, it may be prudent to pay some of the invoices using your line of credit.
Late payments can have you lose value suppliers, affecting your inventory management. Not to mention the time and effort often required to find reputable suppliers.
The only way to avoid these inconveniences is to settle outstanding invoices using a portion of your line of credit.
Delayed salary payments is a leading cause of employee turnover. Late salary payments can also dampen staff morale, reducing their overall productivity.
A business line of credit can come in handy in settling your staff salaries and wages during austere times. It’s a welcome respite as you wait for your financial situation to improve.
However, only utilise a line of credit for salary payments if you’re convinced that your cash flow problems are temporary.
When planning to procure a new business appliance, your first instinct may be to seek an equipment loan.
However, traditional equipment loans may come with unfavourable lending terms. A more viable alternative would be to explore a business line of credit.
A business line of credit is particularly recommended if you’re not already sure about the equipment’s actual purchase.
One best practice in business finance is to always have an emergency fund that you can draw from to finance unforeseen expenses.
However, setting up an emergency fund takes a great deal of time and financial discipline. In the meantime, unexpected expenses might keep popping up.
A line of credit can help to address financial emergencies. Just ensure the expenditure in question is directly tied to your business operations.
Like traditional business loans, the effectiveness of a line of credit depends on how you utilise it. We cannot overemphasise the importance of using a business line of credit for the intended purpose.
Needless to mention, always repay your line of credit on time. Timely repayments reflect favourably on your credit score, potentially entitling you to higher borrowing amounts in the future.
