Congratulations! Your small business now has access to a Line of Credit (LOC) from your community bank. Now what should you use it for?
Advantages of credit lines
What are the advantages to applying for or receiving an LOC?
- LOCs supplement the use of business credit cards and are used for long-term projects, rather than everyday expenses like business lunches and travel.
- They offer revolving access to credit, up to the maximum amount granted by your bank, but you pay no interest until you actually draw on that credit line.
- You have no fixed monthly payments like a credit card.
- LOCs are unsecured, which means your business does not have to post collateral to be eligible.
- Typically, LOCs are based on an adjustable, market-based rate that is far less costly than interest rates on credit cards.
Bank loans, or term loans, are another alternative to LOCs. A standard commercial bank loan is usually made for one year or more. It is repaid in regular payments over a fixed period of time until maturity. Typically, monthly or quarterly payments of interest and principal are made to the lender. Interest may be fixed or floating. Loan maturities vary, and you should consult with your community banker to learn about which type of term loan is best suited to your needs – for working capital, equipment or real estate. A borrower must pledge collateral to receive a commercial bank loan.
Businesses put their LOC to use for a variety of purposes, including working capital and investments for expansions.
Common applications for LOCs include:
- Covering short-term cash flow shortages, such as building up inventory before a big holiday sales season
- Purchasing inventory when it is available at a very low price
- Covering occasional payroll shortages or gaps in your accounts receivable
- They can also help stabilize your cash flow and can come in handy if a business emergency occurs
When you want to expand – buy a new computer or other equipment, increase your business space or add a new product or service – LOCs are there to help. But before making any investments, you must have a clear picture of your current cash flow, assets and liabilities and make sure there is a realistic demand for your expanded business.
Prior to undertaking any large financial commitment at your business, always ask your community banker for an evaluation of your current business operations and your expansion plans.
There are some caveats to LOCs
- Business credit cards are easier to obtain than a line of credit from a bank. But credit cards carry much higher interest rates than credit lines and running higher and higher monthly balances on business credit cards can be dangerous for your small business and your credit rating.
- Do not use your business LOC for personal or family expenses.
- No type of credit should be used to bail out a failing business. If you see big problems developing in your business, consult with your community banker as soon as possible, before the damage becomes irreparable.
Sources: U.S. Small Business Administration (SBA), Kabbage, Fundera Ledger, QuickBooks, Money, smalltownmarketing.com, Inc., Entrepreneur.