Pros and Cons of a Business Line of Credit
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As a business owner, at some point, you may need funding to purchase equipment, provide a platform for expansion, or just buffer up your working capital.
There are many types of loan options available depending on what you plan to use the money for. For example, equipment loans may be used to purchase machinery, while term loans can help pay for a new building. One option that is often ignored is a business line of credit.
What Is a Business Line of Credit?
What is a business line of credit? A business line of credit is similar to a credit card in that there is no initial amount disbursed. Instead, the borrower is approved to borrow up to a specific amount.
They may decide to take less than the approved amount or withdraw all of it. As the loan is repaid, the authorized amount becomes available to the borrower again.
Getting a business line of credit allows a borrower access to funds for any business purpose. It may be used on a just-in-case basis, or it could go towards purchasing inventory or equipment. As long as the money is used for business spending, there are generally no limitations on how it is spent.
How Business Line of Credit Works
If you’re wondering how business line of credit works, you’re not alone. Many business owners are unfamiliar with a business line of credit. Commercial and SBA loans are top of mind when most owners think of business loans.
A business line of credit operates similarly to a credit card in that the company will gain access to a certain amount of funding. They can choose to withdraw amounts up to the amount approved and then make monthly payments to repay the loan.
Since the line of credit is revolving, there is no set schedule for repayment like a term loan would have. Instead, the company can withdraw funds as the balance is repaid.
There is no end date for the loan, although most banks choose to review their borrower’s qualifications regularly to ensure they still meet the approval requirements for the loan.
While a business line of credit is similar to a business credit card, the key difference is how the money can be obtained. While a business credit card may require the borrower to use the card for purchases and have a limited amount approved for cash withdrawals, money from a business line of credit can be transferred into the company’s primary checking account.
This method allows the money to be removed as cash, obtained through the company’s debit card, or transferred to another account for payments or other purposes.
Pros and Cons of Business Line of Credit
When you're considering what type of loan is appropriate for a business, it's important to consider how the loan is intended to be used. You should also review the details of the loan or line of credit. Here are the pros and cons of a business line of credit.
There are several benefits to getting a business line of credit.
Helps Streamline Cash Flow
Most businesses don’t have steady revenue or collections. Instead, there may be months where sales are high, and other months may have fewer sales to report.
Slow collections can make cash difficult to come by. In these cases, having a business line of credit available can help shore up cash reserves if needed. The business can use the line of credit to pay for employee salaries or other necessary expenses.
Only Pay for What Is Used
While different types of loans involve disbursing the amount borrowed at the beginning of the loan, you only withdraw the amount needed at that time with a business line of credit.
Instead of paying interest on the entire amount the company is approved for, interest is only charged on the actual amount used. This can help the company control the amount of business debt and minimize excess borrowing costs.
Great for Flexibility
There may be times when the company needs to take advantage of an opportunity. For example, perhaps there is a limited-time sale on standard, non-perishable parts your business uses to manufacture inventory. If it makes financial sense, even if you don’t necessarily need the parts today, you could purchase them at a discounted cost using the business line of credit, which would reduce the overall costs associated with the inventory.
Build Business Credit
Building business credit is extremely important, especially if you plan to expand and grow your business. Bad or no credit can prevent a business from having the ability to scale the business. The company may be unable to obtain necessary machinery or get better interest on loans in the future.
If a business owner decides to obtain a business line of credit to help build the company’s credit history, it's essential to make sure all payments for the loan are made on time each month. Doing so can help the company obtain better loan terms in the future.
As with any loan, there are some disadvantages to a business line of credit. The drawbacks should be a part of the review process when deciding on appropriate funding to support a business.
Fees for a business line of credit may be steep, depending on the lender. It’s important to do a thorough review of the loan terms before agreeing to take out a business line of credit.
Consider the interest rate, any finance charges, and whether the loan compounds interest over time. These charges can significantly increase the overall loan cost, so make sure you review them in detail.
May Be Difficult to Obtain
When obtaining credit for a business, most lenders will require the company to submit specific documentation before approval. These documents can include business and personal tax returns, financial statements, details on the company’s bank accounts, and business planning documents.
In some cases, the business owner may be required to personally guarantee the loan before it is approved.
Low Borrowing Limits
For companies seeking to substantially increase the amount of debt financing available to them, a business line of credit probably won’t make much of a dent.
These types of loans may come with low credit limits – sometimes just a few thousand dollars. Thus, if the company is trying to purchase an expensive machine, another type of loan may be a better option.
Getting a Business Line of Credit
To obtain a business line of credit, you’ll need to find a lender that offers them. Before applying for the loan, ask what sort of documentation is required and inquire about the costs associated with the loan.
Most banks won’t be able to provide you with the total cost of your loan until after they have reviewed the company's financial history, but they may be able to give you an estimate.
Fundid Capital is an online lender with a variety of loan products available for businesses in need of financing. Their application process is much shorter than most traditional banks, and in many cases, a company can receive funding within 24 hours.
Get the Help You Need with Funding Your Business
The pros and cons of a business line of credit are important to understand when determining the best type of financing for your business.
Need funding to grow your business? Learn more about Fundid Capital to find out how you can get capital to grow faster.