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Business Credit Lines: Knowing When and If You Should Use Them

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For so many entrepreneurs, the dream of opening their own shop comes to fruition eventually. They save, borrow and work hard to turn their business ideas into realities.

Hanging the “OPEN” sign on their doors cements for them that they everything was worth it. Then, something unexpected happens that creates a cash crunch. “What to do?” many worry. The answer may entail taking out a small business line of credit. 

If you are a small business owner, understand that there may be times when lines of credit are essential in providing the bridge financing you need to get you over a financial bump. On that same note, be sure to understand the ramifications of these options. Taking on debt of any kind must be thought through very well.

Short-term need for cash

Operating your own business can come with having to deal with unforeseen financial issues. The issues can range from wanting to build your inventory for the holidays, or temporarily supplementing your working capital, notes SunTrust Bank. 

When these issues come up, small business owners often think to themselves, “what if I had just a little more in my business reserves to tide me over until I’m over this hurdle.”

That’s where business lines of credit come into play. Revolving lines of credit can help with primary day to day operations, such as meeting payroll, purchasing supplies, increasing working capital or obtaining extra inventory; it also provides many other benefits, according to the Small Business Administration (SBA) before applying, however, business owners should ask themselves: “Are my funding needs short term?” 

The SBA states:“A business revolving line of credit provides companies the flexibility needed to meet their short term funding needs. When the need for cash is there, funds are there. By having access to cash on demand, you can take your mind off of money and focus on running and growing a successful business.”

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Extending you a line

With revolving business credit lines, a bank or merchant may offer “a specified amount of always available credit for an undetermined amount of time” according to the SBA. Once the borrower repays the debt, they can borrow again. 

As the business owner makes payments on the revolving credit line, those funds become available for borrowing again, according to the SBA. The agency adds that the credit limit may be used again and again “as long as you do not exceed the maximum limit.”

The SBA states: “Having access to a source of funding is an essential part of success in business, but not all forms of financing are created equal. Unlike other kinds of lending, a revolving business credit line offers many advantages over other types of funding.”

[Learn Ideas on How to Fund Your Startup or Small Business]

What sets lines of credit apart from traditional loans?

If you’ve found yourself in a cash flow pinch as a small business operator, the last thing you want is to be tied to a strict traditional loan. These loans often require the borrower to make set monthly payments that can potentially present a challenge to the growth of a start-up business, the SBA points out.

Revolving credit lines offer flexible repayment terms. For example, if you have a slow month, revolving lines of credit may allow you to just pay the minimum amount due. These credit lines also allow the borrower to spend the cash as they see fit on their business. Because they are revolving, the owner can use the money for multiple purchases compared to a loan that can only be used for one purpose.

SBA Outlines Perks of Business Credit:

– Personal and Business Separation– One of the challenges many small business owners face is keeping personal and business expenses completely separate. The benefit of a revolving business credit line is that it enables you to streamline and track your business expenses since your credit line is dedicated solely for business.

–  Access to Cash on Demand– Unlike a traditional loan, a revolving credit line enables you to source funding before your business actually needs it. Because of the cyclical nature of business, you may find yourself wanting to borrow money to take care of your company’s short terms needs.  By being able to access funds on the credit line at any time, you can keep your business running smoothly, day in and day out.

– Builds Business Credit– Businesses need to establish ratings with the major business credit reporting agencies. Using a business revolving line of credit allows you to build a positive payment history that appears on your company’s business credit report. This will allow you to potentially obtain future credit for your business based on your company’s creditworthiness.

Ready to get started? 

Once you’ve decided that your circumstances are so that a line of credit is the best option, your next step is understanding how they work. 

SunTrust notes how its business credit lines work.

•    It pre-authorizes borrowers up to a specific amount

•    That amount is secured by the borrower’s business assets. However,  in some cases, an unsecured option may be available if certain credit conditions are met

•    Interest only accrues on the outstanding balances, of the lines of credit. This could lead to varying interest rates

Types of business lines of credit

Understand that there are two main types of unsecured business lines of credit. They are traditional and non-traditional.

The traditional business line of credit issued by a bank calls for a substantial amount of documentation to qualify. Information that will need to be provided includes your business tax returns, bank account information, and business registration documents.

Also, once a line is issued an annual financial review is required to maintain the line of credit. While a traditional credit line offers various benefits such as check-writing privileges, it tends to be the most difficult line of credit to obtain and maintain – SBA

To qualify, you must have decent credit. 

Traditional unsecured lines of credit tend to be the most difficult to obtain and keep. Consider this from the National Small Business Association: “29 percent of small business owners report having their lines of credit reduced in the last four years and nearly 1 in 10 had their line of credit called in early by the bank.

If your credit is below par, and you don’t want to be bothered with yearly reviews, excessive documentation and level of scrutiny that comes with a traditional credit line, the nontraditional route is best for you. 

Advantages of non-traditional business lines of credit

Some of the advantages of non-traditional business lines of credit, as noted by the SBA, are as follows:

•    The ability to use as much or as little credit from your line as you want to, anytime and anywhere

•    You can obtain business credit cards that often carry high credit limits, making it extremely convenient to finance larger business purchases. 

•    With business credit cards you have flexible payment options compared to a fixed month-to-month payment that comes with a business loan. When you tap into your credit line, you have three options every month. You could pay the full amount due, pay at least a minimal portion of the balance or pay more than the minimum amount due.

•    Business credit cards enable business owners to separate personal and business expenses while benefiting from business credit reporting. This makes it possible for business owners to establish the creditworthiness of the business itself. 

•    Small business credit cards that report solely to the business credit agencies allow business owners to protect their personal credit ratings while building their business credit.

Non-traditional credit lines are not without drawbacks. Because there is no set payment schedule, some business owners may be tempted to just pay the minimum monthly payment. However, carrying debt can cause the total amount, which includes interest, to shoot up quickly.

In Conclusion

There are many choices to pick from when considering a business line of credit. Talking to your local SBA office or accountant can help you decide which one is best for you and your business.

Author: Tedra Williams DeSue

Tedra has been a finance/investment writer for more than 20 years. Her areas of expertise range from dividend growth stocks to municipal and corporate bonds. She also writes about personal finance and small business issues. Her work as a finance writer has been published in The Bond Buyer, Forbes, The Street, Yahoo Finance, Insider Monkey and NBC News.

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