The Importance of Small Business Lines of Credit
You’re a small business owner. Your company experiences a small fiscal emergency, but you don’t have the necessary cash on hand. Your first thought? “I should apply for a loan.”
That’s perfectly logical, but a surprisingly bad place to be in. Because in many cases, by the time a business realizes it requires funding, its options might be limited, or even nonexistent. That’s because lenders are often more hesitant to extend credit to businesses that are already struggling, and if they are willing, the lender will likely set onerous terms to offset the significant risk they’re taking on.
This is why the best time to secure a lifeline is before you need it — and that’s where a small business line of credit comes in.
What Is a Small Business Line of Credit?
A business line of credit (LOC) is a flexible financing tool that ensures liquidity is available before a company actually needs it.
Instead of taking on a lump-sum loan as soon as you need the money, business owners can open a line of credit at any point, but only use it when necessary — similar to how a credit card works. This can provide a cushion for when you have to bear an unexpected expense or fluctuating cash flow, or a handy boost when a growth opportunity arises.
How Does a Business Line of Credit Work?
Unlike traditional loans, which provide a fixed amount of money upfront, a business LOC gives companies access to a revolving pool of funds. Business owners can borrow as needed up to a predetermined limit. Interest is charged only on the amount borrowed, and once the debt is repaid, that credit becomes available again for future use.
Business LOCs are either secured or unsecured:
- Secured line of credit: Requires collateral — cash, real estate, investments, and other assets. Because collateral reduces the lender’s risk, it’s easier to obtain a higher credit limit and/or lower interest rate.
- Unsecured line of credit: Does not require collateral. The tradeoff: stricter qualification criteria and higher interest rates.
Both LOCs are valuable tools that allow you to get through any approval process long before you ever need the immediate access to working capital they provide.
The Benefits of a Small Business Line of Credit
A business LOC offers numerous advantages, making it a versatile form of small business debt. Here’s why business owners should consider securing one:
1. Cash Flow Management
Some small businesses experience fluctuations in revenue due to seasonal changes, market demand, or delayed customer payments. A business LOC can help bridge these cash flow gaps, ensuring you can cover your payroll, rent and other operating expenses without disruption.
2. Emergency Fund for Unexpected Expenses
Equipment breakdowns, sudden changes in market dynamics and natural disasters can create financial strain. A line of credit acts as a safety net, allowing businesses to handle unforeseen expenses without depleting their reserves or personal funds.
3. Growth and Expansion Opportunities
Having immediate access to capital allows small businesses to take advantage of time-sensitive growth opportunities. Whether it’s purchasing inventory in bulk at a discount, expanding to a new location or investing in marketing initiatives, a business LOC provides funding that allows a company to act swiftly.
4. Flexible Borrowing and Repayment
Term loans require fixed monthly payments, but an LOC offers flexibility. Business owners can borrow as much or as little as needed, only paying interest on the amount used. This makes it a cost-effective option for managing short-term financial needs.
5. Builds Business Credit
Consistently using and repaying a business LOC on time can help build a strong business credit profile. A higher credit score improves a company’s ability to secure future financing with better terms and interest rates.
When Should a Business Open a Line of Credit?
Many business owners wait until they are in a financial crunch to seek funding. However, the best time to secure an LOC is before you need it.
Banks and lenders prefer to extend credit to businesses that demonstrate stability and strong financials. So by applying for an LOC when your business is performing well, you increase your chances of securing a favorable limit and interest rate.
How to Qualify for a Small Business Line of Credit
Lenders evaluate several factors when determining a business’s eligibility for an LOC, including:
- Credit score: Higher business and personal credit scores increases the chances of approval and better terms.
- Revenue and cash flow: Demonstrating consistent income and the ability to repay borrowed funds is crucial.
- Business history: Lenders often prefer businesses that have been operating for at least two years.
- Collateral (for secured LOCs): If you apply for a secured LOC, your business will need to provide collateral.
To improve approval chances, businesses should maintain organized financial records, pay off existing debts on time and regularly review their credit reports for accuracy.
Be Smart About Your Small Business Debt
A small business line of credit is an essential tool that gives your company financial flexibility, cash flow stability and a better positioning to take advantage of growth opportunities.
But like with a loan, venture capital and any other source of funding, you need to make sure you fully understand what you’re getting into, and that you can get the best terms. And we can help. McManamon & Co. provides a wide range of consulting services, which include helping you establish corporate banking relationships, finding funding sources and seeking investors.
Ensure that you’re being proactive — not reactive — with your small business finances. Call McManamon at 440.892.8900 or contact us online today.
Tags: consulting, financing, McManamon, McManamon & Co., small business, small business accounting, small business consulting, small business finances, small business financing | Posted in Financing, McManamon & Co.