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According to research done by the Australian Centre for Business Growth, 25% of the surveyed CEOs attributed the failure of small and medium-sized companies to – poor planning, poor management, and poor leadership.
14% of them blamed it on the lack of financial knowledge required to run a company successfully. Don’t let your company become another statistic. Be in the know.
One of the most important aspects of any successfully run business involves understanding the ins and outs of cash flows. This is at the heart of every enterprise.
You need to ensure that you have ample cash coming in at all times, to side-step any unexpected challenges that may arise, and offset any potential bankruptcy risks.
If you ever find yourself cash-strapped, you need a quick, effective, and efficient way to access capital. The keyword here, being “quick”.
Sure, you could go to a bank or any other credit financing institution. But, will you get the money you need in time? Is a business line of credit a good idea to consider? How does it work, anyway? This article explores the answers to these questions in depth.
What Is a Business Line of Credit and How Does It Work
This is a flexible form of fast financing that allows companies to access quick cash when they need it. It works almost like a business credit card, allowing you to transfer money from your “line of credit” to your business bank account.
But, unlike a cash advance or credit card that comes with pretty hefty fees and high annual percentage rates (APRs), a business line of credit (LOC) is a much more cost-effective solution, which allows you to spread out your payments over longer, predetermined repayment periods.
You could also pay it all back at once if you want to save on interest. It is essentially a revolving loan that gives businesses a chance to access a specific amount of cash quickly, to meet their short term business needs.
Suppose you need financing to meet short term capital requirements like:
- Boosting seasonal cash flow demands
- Financing a marketing campaign
- Purchasing inventory
- Repairing equipment that’s critical to your business operations
All these are considered “short term” requirements.
Difference Between a Business Line of Credit and a Term Loan
While the two may appear similar, they are quite different from a lender’s perspective. A term loan involves a fixed amount of funds credited to the borrower’s bank account in lump sum form. This is to be paid back in a series of periodic payments over a predefined time frame.
A LOC, on the other hand, has a credit limit that a business can borrow against, any time they need it. They can then use it, repay it, and borrow again if they need to. They are used for short-term purposes for immediate revenue-generating activities.
Is a Business Line of Credit a Good Idea – Weighing the Pros and Cons
The short answer is yes – if you use it for what it is intended for. Here are a few pros and cons of business LOCs to help you determine whether it is right for you.
The Pros
- Balances-out cash flow – Every business has its peak seasons and its slow seasons. Some may feel it more than others. If you have a winter store, for instance, you might find that your sales peak both in the period leading up to winter and during winter itself.
On the flip side, sales might dip during the summer months. Cash during this period may be a little tight, making it difficult to meet your operational expenses like payroll. Since you can’t very well use a credit card to pay salaries during those three or four months, a LOC is a handy solution to even-out the cash flow when business is slow.
- Interest is only payable on the amount you use – Most term loans come with a prepayment penalty. This isn’t the case with a LOC. Depending on the agreement you have with your lender, you can pay interest only on the amount, and pay off the balance in full at any time without any charges.
- Allows you to grab opportunities when they arise – If an incredible opportunity presents itself, you may only have a limited window within which to act. Say your supplier decides to slash the cost of materials by half.
While it’s certainly a great offer to take advantage of, you may not have adequate cash to do it. A LOC would allow you to grab this opportunity which, if you think about it, will end up saving your company money in the long run.
- Builds your business’ credit history – The more times you borrow and pay-off your debt responsibly, the better your credit score becomes. This opens the door to better lending terms on the future loans you apply for.
The Cons
- Additional fees – Although business LOCs provide immediate access to fast cash when your business needs it, always read the fine print. Ensure that you understand all the fees and extra charges your LOC might incur. However, these will vary depending on the agreement terms you have with your lender.
- It might be hard to qualify for a LOC – Most mainstream lenders require that you have two years’ worth of business history to qualify. And, even then, the requirements are a lot. There are several business documents you need to provide.
If you don’t meet the qualification threshold required, you may have to consider alternative sources of financing. Online non-bank lenders, however, have less stringent requirements.
- Credit limit – LOCs have low borrowing limits compared to other financing options. If the short term costs of your project are higher than the borrowing limit, you might have to consider another funding option.
Use a Line of Credit to Take Your Business to the Next Level
So, to wrap up, is a business line of credit a good idea? There’s no right or wrong answer to this. It all depends on what you need the money for.
With any decision you make to incur business debt, the end always has to justify the means. If you use it for the right reason, which is to grow your company, then it’s certainly a good idea.
Not sure where to find a line-of-credit lender? Use our online tool today to help you find the right one for your business needs.
