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- A business line of credit is a flexible and powerful tool for business owners who need a renewable source of borrowed short-term funding.
- Though not ideal for all types of expenses, a business line of credit can help to regulate cash flow and stabilize operations.
- Alternatives to business lines of credit, including grants, merchant cash advances and business credit cards, are available as well.
A business line of credit can be a powerful tool to help an entrepreneur establish and grow their small business. Like a credit card, a business line of credit is a kind of revolving credit, providing an ongoing and versatile source of funds.
Whether capital is needed to cover payroll, purchase equipment or build inventory, a business line of credit can help tackle these goals and others when funds are not otherwise immediately available.
What expenses should you use a business line of credit for?
A business line of credit is flexible in that it can be used for almost any business-related expense. But this source of credit is better suited to some expenses than others.
Because a line of credit is renewable and can be drawn upon over time, it can be a reliable funding source for near-term needs, especially recurring ones. Think payroll or monthly utility bills. You can return to the well repeatedly, unlike with a term loan, which is paid out as one lump sum.
Most lines of credit are secured or unsecured and have a smaller maximum amount than term loans offer. But as you make payments on your line of credit, you can expect funds to be available again for future use.
If you plan your expenses and funding sources in advance, you may use a line of credit to float periods of leaner income for your business. While you may turn to other loans for larger, one-time expenses, a line of credit can be useful to stabilize cash flow over the long term.
How not to use a business line of credit
Because the funds available through a business line of credit tend to be more limited than with a small business loan, you may wish to avoid making your most significant purchases on a line of credit.
You will want to keep your line of credit available to use, which means paying off any balance quickly. That means you may look to fund larger expenses — like vehicles, major equipment or real estate purchases — with a term loan, equipment loan, working capital loan or another loan designed for long-term repayment.
Pros and cons of a business line of credit
Like other types of business financing options, business lines of credit have their pros and cons. For example, they are an accessible option that improves cash flow, yet they can have higher interest rates than regular business loans and potentially damage your credit score.
|Improved cash flow||Fees|
|Help build relationship with lender||May have short repayment terms|
|Help build business credit||Potential risk to credit|
Ways to use a business line of credit
A business line of credit is a flexible funding source that you can return to regularly when it is needed to float expenses.
Business owners should exercise caution when using a business line of credit, as interest rates tend to be higher than for term loans. With comparatively high interest rates and low limits, entrepreneurs should use this funding source strategically, keeping it available for short-term needs that can be paid off relatively soon.
1. Stock up on inventory before a busy season
If your business relies on seasonal traffic, your line of credit can be a great way of purchasing inventory in anticipation of a high sales period.
2. Cover payroll
For businesses that must run payroll before earnings hit their accounts, a business line of credit can keep things running smoothly while waiting for sales or invoices to clear.
3. Make small equipment purchases
Though major equipment purchases may be best suited for loan funding to pay off over time, smaller equipment needed for daily operations (such as a point-of-sale system) can be a good fit for purchasing with a business line of credit.
4. Complete necessary repairs
If you need to fix a vehicle or piece of equipment to keep your doors open, a business line of credit can help ensure everything remains in working order. If your lemonade stand urgently needs a working ice machine, for example, paying a repairperson using your business line of credit can be a smart move.
Using your line of credit responsibly
A business line of credit can be a helpful windfall for your business when income is tight. To maximize the benefits and avoid hurting your business finances, manage your line of credit carefully.
Remember that your line of credit is best used for expenses that can be repaid relatively soon. Understanding your line of credit’s fee structure and interest rate can help you to avoid penalties, unnecessary costs or spiraling debt.
Alternatives to a business line of credit
While a business line of credit suits many, it’s not ideal for all. Some businesses might benefit from exploring term loans, grants or another small business financing alternatives.
- Short-term loans: Businesses can secure one time lump sum of cash to be repaid at a fixed rate over a specified term, typically less than two years.
- Business credit card: Like a line of credit, a business credit card gives businesses access to a line of credit that can be used to cover short-term business expenses.
- Grants: This financing option provides non-repayable funds for various business costs; however, they can be competitive.
- SBA loans / CAPLines: SBA loans, including 7(a) loans and CAPLines, offer favorable terms and longer repayment periods, and funds can be used for a variety of business expenses.
- Merchant cash advances: These have quick approval, fast funding and flexible repayment suitable for businesses looking for help covering short-term expenses.
- Invoice factoring/financing: Businesses get immediate access to capital by selling outstanding invoices, but the fees can be high.
The bottom line
A business line of credit is one of several options business owners can turn to for funding operations and regular necessities. By strategically choosing when to employ this kind of funding, business owners can leverage the benefits of a line of credit to remain agile and responsive in their work.
Frequently asked questions
Lenders offer secured and unsecured business lines of credit. A secured line requires collateral, while an unsecured line does not.
Your potential credit line depends on several different factors, but it is possible to secure a line as large as $3 million.
A business line of credit can be used for small business expenses, such as inventory, payroll and vehicle or equipment repairs.