Have you considered obtaining a line of credit to help fund your next big project? A business line of credit is an excellent financial tool that can give businesses access to additional working capital when cash flow needs arise. It offers flexibility, allowing businesses the freedom to access funds quickly and repay them at their own pace. In this guide, we'll discuss how a business line of credit works, what it's best used for, and its advantages for small businesses.
What Is A Line Of Credit?
A business line of credit is an incredibly helpful tool for business owners. It provides flexible access to financing, allowing a business owner to borrow funds when needed and providing the ability to borrow up to an approved limit for future use. They off financial flexibility, as it allows businesses to manage cash flow more effectively and fund growth projects without relying on long-term loans or taking out collateral.
Most importantly, it acts like an insurance policy during the slower months so that you have the capital needed to keep going without having to turn away potential customers. Instead of getting a lump-sum amount, you receive a revolving line of credit that you can use, repay, and use again over a specified period.
Types Of Business Line Of Credit
- Secured vs. unsecured: a secured line of credit means you're using assets like business property or inventory as collateral. On the other hand, an unsecured line of credit doesn't require collateral.
- Real estate line of credit: It's equivalent to a personal home equity line of credit (HELOC). For business, you use your home's equity or equity in other properties to secure a loan.
- Business credit cards: like personal credit cards, business credit cards offer quick access to cash without collateral.
If this financing option looks appealing, it's important to note that the requirements may be different from other types of loans.
General Requirements For Business Line Of Credit
When applying for business loans, your goal is to get the funding. But the lender's goal is to get repaid at a profit. Lenders, therefore, look at many factors before providing the loan.
While the actual line of credit requirements may vary from one lender to another, here are some general factors they may consider:
Personal Credit Score
Although it's your business that's borrowing, lenders may still look at your credit score for two reasons:
- Personal guarantee: This means you will be held responsible for repaying the debt if your business can't.
- Chances of repayment: lenders want to be sure the borrower has skin in the game to increase the chances of getting repaid.
To check your credit score, lenders usually conduct a background check. You need a good credit rating of above 680.
If your score is lower, you can still get a business line of credit. However, your options will be limited and you may go home with a high-interest rate.
Business Credit Score
Apart from running a personal credit check, many lenders may look at your business credit score and reports. Financiers use this information to determine the risk of lending to your business.
If your business is new or doesn't have a credit history, then your credit score may be lied upon.
Business Financial Statements
In addition to looking at your business and personal credit scores, lenders also consider your profit and loss statements and your balance sheet before advancing the loan.
And here, lenders use ratios such as debt to equity, fixed charge coverage, debt service coverage, and current ratios to ascertain your ability to repay the loan.
For instance, many lenders calculate your debt service ratio by dividing your net operating income by your current liabilities for one year. Ideally, this figure should be above 1.25 as it means your operating income is 125% of your liabilities.
The higher the ratio, the better, because it means you're more likely to get the funding on favorable terms. And just like credit score, you can still get approved for the loan if you have a lower ratio. However, you may not get favorable terms.
Time In Business
When considering a business for a line of credit, lenders often take into account the amount of time the business has been in operation. This can be an excellent indicator of a business's financial health as well as its ability to stay solvent and weather economic downturns.
Banks and other financing providers may feel more comfortable lending funds to a business that has been established for some time, as this offers assurance that there is a solid infrastructure in place, and that they are more likely to get their money back.
What Are Business Lines Of Credit Used For?
A business line of credit is a loan that can be used for a variety of purposes, including:
- Purchasing inventory
- Paying suppliers
- Covering unexpected expenses
- Making payroll
- Funding marketing campaigns
- Repairing business equipment
Pros Of Business Lines Of Credits
- Flexible: This allows you to borrow what you need and has few restrictions on how to use it.
- Lower interest rates: lines of credit attract lower interest rates than credit cards and payday loans.
- Continuous access to funds: since it's a revolving line of credit, you can borrow and repay repeatedly.
- Quick and easy: get approved within minutes, making it perfect for women entrepreneurs who can't wait.
Cons Of Business Lines Of Credit
- Requires good credit: lenders usually reserve business lines of credit for borrowers with excellent or good credit scores.
- Maintenance fees: Some lenders subject lines to credit to maintenance, late, and returned payment fees.
- Can damage credit: if you don't pay on time or carry high balances over time, business lines of credit can impact your credit score.
Finding Funding for Your Business
A business line of credit is a flexible financing option for small businesses. With a revolving line of credit, you can draw on the funds as needed and only pay interest on the portion of the line that you use. This makes lines of credit an attractive option for funding inventory purchases or covering gaps in cash flow.
Visit the Fundid Capital Marketplace to get connected with lenders based on your business needs so that you can get the financing you need to grow your business.
Editors note: This blog was originally published on August 3, 2021 and has been updated for accuracy and comprehensiveness.
