When is a business line of credit a good idea? 5 signs your business is ready.
Learn how a business line of credit works and when it’s a good idea to secure one with these five considerations.
For many small business owners, finding ways to expand is a priority — whether by hiring some help, sprucing up your space or bringing in more inventory. But growth takes money. When your cash is committed to other things or revenue fluctuates, a small business line of credit could give your company the financial flexibility it needs to take the next step.
What is a business line of credit?
A line of credit gives your business access to a set amount of financing that you can access as needed for short-term business needs — restocking products, renovations, business expansion, marketing campaigns and more. You pay interest only on the amount you use. And unlike loans, lines of credit allow businesses to access cash without taking on a lot of debt all at once. Plus, when you pay it down, typically those funds become available to access again.
A business line of credit can give you access to cash just when you need it, but as with any financing option, the details matter. Here are the things every business owner should understand.
Key features of a business line of credit
Let’s look at an example of how a business line of credit might work: Say you own a local bookstore and need $50,000 to expand into the space next door. After getting approval for a secured line using your store real estate as collateral, you can access the full $50,000 right away for renovations and inventory.
As you use the funds, interest starts accruing only on the amount withdrawn. For example, if you use $10,000 for renovations, then you pay interest only on that amount and still have access to the remaining $40,000 if you need it. As you pay down the $10,000 of principal, you free up that amount of credit to borrow again.
The benefit of a business line of credit is that you can access the cash, pay it back and borrow again as you go. It’s flexible financing that doesn’t tie up your working capital.
But how is it different from other options like business credit cards? Let’s take a look.
How do lines of credit compare with business credit cards?
At first glance, business lines of credit and business credit cards may seem pretty similar. They’re both revolving credit you can access for funds. But once you dig in, some key differences emerge.
With a line of credit, you can draw what you need, when you need it, and make interest payments just on that portion until you pay down the principal. Credit card balances typically have set minimum monthly payments and interest charges on the full balance each billing cycle.
One area where credit cards have an advantage is the approval process. With a credit card, the process can be quicker and easier because issuers are looking more closely at your personal credit history than your business’s. Lines of credit, on the other hand, have much higher credit limits but involve a more rigorous approval process that examines your business performance.
Here’s the main takeaway: Credit cards are great for covering smaller everyday expenses like office supplies or meals out with clients. Lines of credit are meant for larger, less-frequent financing needs like expanding locations, funding inventory orders or covering gaps in cash flow.
How do you use a business line of credit?
Business lines of credit can really help when you need access to capital at lower interest rates than credit cards offer. Once approved, you can draw on the funds as needed without reapplying each time.
Let’s look at how a line of credit might work. Imagine you own a landscaping business and want a line of credit to cover winter costs until spring contracts resume. Here’s what you might need help with:
- Revenue fluctuations. A line of credit provides funds for expenses like payroll and supplies during the slow season when revenue dips. Rather than tying up cash reserves to operate through winter, you can use your line of credit instead.
- Cash flow gaps. When spring arrives and business picks up again, the line lets you smooth out those cash flow gaps and keep operating smoothly. No need to scramble for financing or stall operations.
- Business investments. If an opportunity comes up to invest in a business website or employee training, the credit line lets you jump on it without drawing from your working capital.
- Emergency expenses. If a major truck repair or a new equipment is needed, the line offers a backup source to draw from rather than scrambling to come up with the funds.
In short, a line of credit can provide you with business funding to cover things like seasonal revenue changes, emergency costs or unexpected growth opportunities.
Is a line of credit right for you?
How do you decide whether getting a line of credit makes sense for your specific business? Here are some questions to consider:
- Do you have slow or busy seasons that make your cash flow go up and down at certain times of year? A line of credit can help smooth out those highs and lows.
- Are you planning any big purchases or expansions soon that require extra financing? A line of credit can provide funds to draw upon as needed for growth plans.
- Is your business missing out on opportunities because you don’t have capital on hand? A line of credit allows you to act fast when a good opportunity comes up.
- Do you have a rainy-day fund to cover repairs or emergencies? If not, having a line of credit can be a way to cover unexpected costs that come up.
- In short, a line of credit can provide you with business funding to cover things like seasonal revenue changes, emergency costs or unexpected growth opportunities
For instance, a small marketing firm might decide to establish a $30,000 line of credit because customers are often late with payments. Having a line in place will help the firm manage payroll through cash flow dips.
Likewise, if you’d like to smooth out cash flow for your business, set up a backup fund for emergencies or simplify payments to your lenders, a line of credit might be the right move.
Using a business line of credit to grow
For many businesses, a line of credit can be a helpful source of flexible financing. Compared with conventional loans or high-interest-rate credit cards, lines of credit let you access money as needed instead of taking it all in a lump sum you have to pay interest on. This makes a line of credit handy for all kinds of business needs, such as managing slow seasons and buying new equipment.
Look at your own business situation to see if a line of credit fits your needs. You may find that a line of credit can provide the funding your company needs as it grows, giving you a financing option that evolves along with your short-term needs and long-term goals.
Want to talk about more ways to strengthen your business or grow your company? Reach out to a Chase business banker today. We’re always ready to help.