Small businesses need access to a steady stream of funding to ensure survival in a competitive market. A business line of credit is an indispensable tool for small businesses looking for additional working capital to meet day-to-day business needs.
Want credit but haven’t incorporated your business yet?
The bank might require that, so if you are still just a sole proprietor, take the time to learn about how to start an LLC before applying for a business loan.
What Exactly is a Business Line of Credit?
A business line of credit (LOC) is a financing solution that provides business owners with easily accessible capital. Once approved, you will receive access to a predetermined amount of capital to use as needed.
The value of your credit limit and rates of the loan primarily depend on your credit history. While businesses with low credit scores are welcome to apply, the higher the credit rating, the better your chances of getting approved.
The terms of a business line of credit vary between three months to five years.
The repayment schedules also vary depending on the lender you’re working with. Some may ask for monthly payments, while others ask for weekly, biweekly or even daily payments.
And this isn’t just for retail businesses either. All kinds of businesses from solopreneurs to B2B, to a warehouse line of credit, are all available. So just check with your lender about your situation.
Here are three reasons why a business line of credit is an attractive option for small business owners:
1. Spending and Repayment Flexibility
You’re free to use the funds from a business line of credit as you deem fit, giving you more flexibility than you normally get with conventional loans like CDC/504 loans or equipment financing. You’ll be able to allocate capital where and when it is needed the most.
Unlike business terms loans that come with fixed monthly payments, an LOC offers a more flexible repayment option. You only have to repay the money you withdraw, plus interest.
The repayment schedule set by your lender – typically a monthly statement – will reflect the amount of credit used and the interest on that credit. Once the credit and interest are repaid, your credit limit is restored to the original amount and you can withdraw from it again as needed.
Fixed monthly payments can be challenging for startups and small businesses.
A business line of credit makes repayments more convenient because you can pay off a higher amount of the balance when revenues are up and repay the minimum when revenue is low. For example, if a small business takes out an LOC to finance advertising campaigns, they’ll likely attract new customers and generate more sales in the process.
The business can quickly repay the borrowed capital because the ads (hopefully) brought in more revenue.
The spending and repayment flexibility an LOC offers gives small businesses the financial freedom to make sound decisions for their company.
2. Improving Your Credit Rating
Even though a business line of credit offers immediate spending flexibility, you may still need additional financing at some point down the road. Small business loans – especially the ones from the Small Business Administration – offer higher loan amounts with affordable interest rates, but you’ll typically need a credit score of at least 620 to 640+ to qualify.
New businesses, in particular, need time to build up their score.
Business owners who need to build or improve their business credit rating usually take out a business line of credit. This is because you can build a positive credit history and increase your score simply by making payments on time and keeping a low balance.
Therefore, a business line of credit gives you the opportunity to become a reliable borrower, making it easier for you to secure additional working capital from lenders and investors in the future.
3. Lower Interest Rates
The interest rates of most business lines of credit are based on the prime lending rate. This rate fluctuates from time to time, but it’s usually lesser than a credit card’s interest rates.
The rate will stay at a minimum if you consistently pay on time. Eventually, you’ll be able to enjoy higher credit limits and a cheaper access to working capital.
Missed payments, however, can cause the rates and debt to accumulate, limiting your access to capital and stunting the growth of your business. If you are going to take out a line of credit, make sure you’re able to make repayments on time, otherwise it will become a burden instead of a benefit.
The Bottom Line
A business line of credit offers numerous benefits to small businesses, but you need to use the money wisely. It’s easy to get swayed by its convenience and ease of access.
It’s best to use the funds for short-term funding needs like paying for daily business expenses, financing marketing campaigns or buying equipment. Set a budget on how to use your line of credit and stick to it. In no time, you’ll start to reap the benefits of having a business line of credit.