A business line of credit can be a helpful alternative to a business term loan. These revolving funding sources let you borrow up to a preset limit, repay the lender and then borrow that money again. But if you don’t know how to use a credit line wisely, you might not get the maximum benefit to your business. You could even hurt your finances.

Use these six tips to manage your business line of credit well.

1. Be strategic about withdrawals

A business line of credit differs from a term loan because you don’t get a lump sum of cash. Instead, you have a revolving line of credit to use when needed. It works much like a credit card: You must pay interest on borrowed funds. As you repay the balance, that amount is available to borrow again. 

Businesses can use a line of credit to bolster cash flow during slow times — for example, if your business is seasonal and you need working capital during the off-season. Lines of credit can also help cover short-term expenses, such as needing to purchase inventory while being cash-poor because of outstanding invoices.

However, you shouldn’t use your line of credit when you don’t need to. It might be better to look for efficiencies and cut back on spending — eliminating or reducing your need to borrow — rather than taking on debt that you’ll need to repay with interest.

And if you are continually losing money on operating costs, using your LOC isn’t the best option. Ongoing losses likely signal you have a bigger problem than a line of credit can fix. If you have a leaking ship, it’s better to patch the leak than keep bailing water.

2. Account for fees

While you usually don’t have to pay interest on a business line of credit until you spend money, you may have to pay some fees. Understand what fees you will pay and why so that you can budget accordingly. 

Typical fees may include:

  • Origination fee: A one-time fee charged when you open the business line of credit
  • Maintenance fee: Monthly or annual fees for holding an account
  • Inactivity fee: Fees that may be charged when you don’t draw funds from the account often enough
  • Draw fee: A fee charged when you spend money from the account
  • Renewal fee: A fee charged if you renew the LOC for an additional draw period

3. Understand the interest rate

Typically, you start accruing interest on a LOC when you draw funds. Know your interest rate and calculate how much you will need to pay in interest when you decide to draw from your line of credit. 

For example, let’s say you use $10,000 from your business line of credit and it has an interest rate of 10 percent. If you want to pay off the balance within four months, you will accrue about $200 in interest, depending on the size of your monthly payments. You can use a business loan calculator to anticipate these costs before you borrow.

Some business lines of credit have fixed interest rates, and others have variable interest rates. 

4. Pay down your balance wisely

When you spend money from your business line of credit, the quicker you pay down the balance, the less interest you will pay. Pay the balance as quickly as possible to avoid spending extra money on interest. 

But paying quickly also means making higher payments. If your business is short on cash, that might not be possible or smart. It might be smarter to make smaller payments and swallow the extra interest costs instead of emptying your pockets. Use your knowledge of your business’s cash-flow patterns to set your strategy.

5. Know the monthly minimum payment

Once you borrow money with a line of credit, you typically have to make a minimum payment each month. This monthly minimum differs by lender and your specific loan agreement. It may be a set dollar amount, interest only or a percentage of the balance.

Before you start spending, know the monthly minimum payment, and prepare to pay at least that amount. 

6. Ask for a credit line increase (if it makes sense)

Having a line of credit for your business can help increase your business credit score if you make timely payments and manage it well. Another way to potentially increase your credit score is to ask for a credit line increase after the account has been open for at least a few months. If your limit grows but you keep the same spending habits, your credit utilization ratio will decrease — and a lower ratio may mean a higher score.

However, asking for a credit line increase is not always a good idea. It doesn’t make sense to ask for an increase if you recently made any late payments on your account. The lender will be unlikely to say yes.

Why it’s important to manage your business line of credit 

A business LOC can be a great tool for businesses, but it matters that you manage it well. Here’s why:

  • Can boost your business credit if the lender reports your timely payments to business credit bureaus. On the other hand, if you miss payments, you could damage your credit score.
  • Helps build a case for getting a credit limit raise from your lender
  • Overspending and mismanagement can put you in inescapable debt that keeps getting worse as interest accumulates
  • Smart management can fill temporary cash-flow gaps and lead to better financial health for your business
  • Allows you to keep the LOC open to use as a helpful tool for your business

The bottom line

Using a business line of credit can support strong finances for your company, but it can also hurt them. Before you open a business LOC, understand how it works and how much it can cost. Then, make a plan to manage the account.