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Know your (credit)
lines to ease cash flow woes
By Jenny
C. McCune • Bankrate.com
 A
credit line can be a lifesaver for a small business caught between
paying suppliers and awaiting payment by its customers. Used wisely,
it can help finance growth and help a small company travel across
the peaks and valleys of its cash flow.
"It fills a timing gap, a short-term working
capital need," explains Paul Falvey, executive vice president of
commercial lending at First
International Bank of Hartford, Conn.
For example, a clothing manufacturer could draw
on its credit line to buy material in the winter to produce dresses
for the summer season. Once the manufacturer is paid by its customers
(boutiques, department stores, other clothing retailers) it then
pays off its credit line.
Common
credit line users
Most credit lines are for short-term financing of up to a year,
but they can be extended from year to year. They are most commonly
used by:
- Manufacturers that need money to buy the
raw materials to make a final product;
- Seasonal companies that need money to get
through the slow times; or
- Import/export firms that must await payment
(or goods) for a lengthy period.
That said, credit lines can be used by any type
company for a short-term working capital need. For example, a service
company might need a credit line to meet payroll while awaiting
payment for services rendered.
Credit lines work much like credit cards for
consumers, but dispense with the plastic. Companies "charge" their
credit lines when they don't have cash handy, and then pay off the
balance when they can. Each month they are charged on the maximum
balance for the credit line. For example, if a company has used
$25,000 of its $50,000 credit line during May and then pays it down
to $18,000 by May 31, the interest charged would be on the $25,000.
Credit lines may be secured by collateral, such
as accounts receivable, or inventory. Startups need not apply --
they usually are restricted to established companies.
"Typically, these will come into play after
an entrepreneur has worked his way through family, friends, venture
capital and angels," says Don Dailey, partner in charge of middle
market advisory services for the Midwest region of PriceWaterhouseCoopers.
"A company must be viable, have revenues and post a profit in order
for it to be eligible for a credit line."
Use
for operations, not fixed assets
While there are exceptions, credit lines are good for ongoing operational
expenses, rather than fixed-asset purchases. When buying manufacturing
equipment, a small company would more likely finance the purchase
through a regular loan of between five and 15 years rather than
through a revolving credit line.
Credit lines are often referred to as "revolving"
because the amount borrowed varies. It goes up. It goes down. "I
call them 'evergreen' because they roll over for a period," says
Dailey.
The size of a credit line varies with a company's
needs. Banks and finance companies that offer credit lines say they
offer lines that range from $50,000 to several million dollars.
In terms of cost, credit lines tend to be slightly
less expensive than a term loan, but exceptions exist, says First
International's Falvey. As a starting point, a financial institution
will charge anywhere from 1 to 3 percentage points above the prime
rate, which this month stands at 9 percent. The final cost will
be based the bank's assessment of the risk, says Mark Papoccia,
vice president at the Harris
Bank, a Small Business Administration preferred lender based
in Chicago.
Types
of credit lines
Credit lines can take on various guises and purposes, says Anthony
Ruebner, vice president of Financial Institution Partnership for
LiveCapital.com,
an online source for financing, including credit lines. The different
types of credit lines include:
- Credit cards -- While we said earlier
that credit lines are like credit cards without the plastic, in
fact, credit cards are a form of credit lines. These can finance
anything from a $30 business dinner to a $10,000 trade show expense.
- General "revolving" credit line --
This is a true credit line that's usually tapped by placing a
call to your banker, who deposits money into your company's checking
account. They're usually sized from $10,000 to $1 million.
- Trade credit line -- A trade line
is supplier financing. The supplier may give you 90 to 120 days
to pay. You pay for the goods plus an interest charge.
- Asset-secured line of credit -- Most
financial institutions will only grant a credit line if a small
business can secure it with an asset -- generally inventory or
accounts receivable -- since these are the most fluid assets it
owns.
- Nonsecured line of credit -- Much
less common than collaterized credit lines, nonsecured means that
your financing institution waives a requirement to secure the
credit line with assets.
- A credit line that converts into a bank
loan -- Many banks will convert a credit line into a term
loan, Falvey says. "If we see that a customer has a $500,000 line
of credit at the end of the year and it's never dipped below $300,000,
we might recommend converting it into a five- or seven-year loan
and adjust the line of credit to $200,000," he says.
New
twists
In addition, many financial service firms, banks and brokerage houses
have added some interesting twists to traditional credit lines.
For example American Express offers its SBS
Line of Credit. A small business accesses its credit line by
writing a check. The SBS Line of Credit goes up to $50,000 and Amex
charges an annual percentage rate of prime plus 3.9 percent with
an annual fee of $95.
Harris Bank offers overdraft protection on a
commercial checking account. While not a credit line per se since
it's linked to a checking account, it functions much like a credit
line. "If a small business runs into a cash shortfall and overdraws
its checking account, money is put directly into their checking
account to cover the difference," says Harris Bank's Papoccia.
Some financial institutions are in the process
of developing "purchasing cards." They will work much like a credit
line, but to charge against the credit line a company need only
whip out its purchasing card much like a consumer would use a credit
card, says Dan Meder, vice president of credit solutions services
at Dun & Bradstreet.
Landing
your line
Companies interested in setting up a credit line should approach
their regular commercial banker since this financial institution
knows them and their circumstances. Comparison shopping, though,
is a good idea, says Dailey.
In fact, one easy way to comparison shop is
to visit a Web site such as LiveCapital.com, where you can receive
quotes on loans or credit lines from 33 of its participating financial
institutions. It's just a matter of completing an electronic form
and awaiting a response.
In general, financial institutions with a history
of working with small companies can probably do a better job structuring
a credit line to suit your needs, says First International's Falvey.
A large bank that's used to working with a Boeing or another large
company might not have a credit line small enough for your purposes,
whereas LiveCapital.com has credit lines as small as $10,000 and
First International's start at $50,000.
Jenny C. McCune is a contributing
editor based in Montana
To comment on this story, please e-mail the
Bankrate.com
editors
-- Posted: April
13, 2000
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