Why Your Business Should Have a Bank Line Of Credit

by Josh Buscay

business-line-of-credit2Just exactly what is a bank line of credit and who should be using one? A bank line of credit is not a great deal different from a credit card. Primary differences are:

  1. You make draws against your line of credit from time-to-time as you need cash.
  2. You pay interest only on the amount of the loan balance outstanding.
  3. The interest rates on a line-of-credit are generally much lower than on credit cards making the line-of-credit much more attractive cash flow purposes.

How a Line of Credit Works

Let’s say that your bank has arranged for you to have a $100,000 line of credit. You are not obligated to draw any of it at any given time, and you will pay no interest until you actually make a draw (much as you do with a credit card).

Assume that you want to build up your inventory for the holiday shopping season and need $30,000 to do so. After your inventory purchase, you will have $70,000 available and you will start paying interest on the $30,000 that you’ve spent. Unlike a credit card, the interest owed on your line of credit will only accrue on the amount that is outstanding, even if you have not paid the entire balance within the first payment period. In this example, a business owner may make their inventory purchases with a credit card but then pay the balance of the credit card with the line of credit to take advantage of the lower interest costs.

You may have several occasions during the year to borrow on your line of credit. Since your line of credit is intended for short-term cash needs, your banker expects your balance to be paid down as your cash flow improves.

Do not use a line of credit for capital purchases. If you need to expand your building or buy new equipment, arrange a term loan for that specific acquisition. This will keep your line of credit free for your business’s cash flow needs.

How to Establish a Small Business Bank Line Of Credit

A line of credit is often considered an essential tool for growing a business, a fact your bank also recognizes.  If your business has at least two years of making a profit, you may well qualify for a bank line of credit. Your banker has an interest in helping you grow your business and if your financial statements support it, he or she may also offer other borrowing products. Lines of credit for small amounts may not require collateral but larger loans, often require collateral, and or a co-signer.

Most banks are willing to make loans to businesses that have uneven income cycles. You may want to shop around for the best loan terms. Some banks may already have several customers in your industry and do not want more (perhaps a bank examiner’s concern). Accordingly, their terms may be less favorable than some other bank or credit union.

If you are looking to establish a line of credit for your business, contact us for assistance preparing a request for a bank line of credit.