What is a Business Line of Credit and How Does It Work?

Running a business can be overwhelming and may bring along multiple challenges. Most businesses face issues with cash flow and a business line of credit can be an easy solution for companies looking for short-term financial needs. The amount can be used for various purposes, making the task easier for businesses. Traditional and online lenders provide multiple options for a business line of credit (LOC). Before you decide on taking the business line of credit, let us understand more about it and find out if it is ideal for your business. 

What is a Business Line of Credit?

A business line of credit for new businesses is a type of flexible loan. Businesses can borrow amounts up to certain limits and have to pay interest only on the amount that they may have borrowed. Lenders use their own conditions to determine and set limits for a business line of credit. It will even depend on your business’s health and financial situation. You can use business credit lines to fulfill various business objectives, such as funding marketing campaigns, paying payrolls, or meeting the seasonal cash-flow gap.

Types of Business Lines of Credit

Business LOCs can be categorized into two main categories:

• Secured Business Line of Credit – Under this option, businesses will have to provide financial assets and collateral for security purposes. Financial assets may include fixed deposits, mutual funds, stocks, etc. Lenders also have the option to liquidate the collateral in case businesses fail to repay the business line of credit amount.   
• Unsecured Business Line of Credit – The unsecured option allows businesses to get funds without providing collateral. A lender will check the business’s cash flow and balance sheet to understand the current condition of the business’s finances. There might be certain situations where companies will have to provide guarantees to ensure they can repay the loan.

How Does a Business LOC Works?

The functioning of a business line of credit may be similar to that of a credit card. Small businesses will have access to funds and can use them as per their requirements. There is a vast difference in the interest rates of credit cards and business lines of credit. Lenders generally check the company’s annual revenue and other factors to determine how long the current owner has been working. This helps them determine the ability to repay the business loc. The lenders set the entrepreneur's credit limits and interest rates based on these aspects. You should even be aware that lenders review a business line of credit annually and they have the right to increase or decrease the amounts.

Requisites to Get a Business Line of Credit

Different lenders may have distinctive conditions. Here are some of the common conditions businesses will have to meet:

• Businesses must have been in existence for a minimum of six months before applying for the business line of credit.
• The business should have a minimum annual revenue of $25,000 or more.

You should also have a good credit score before applying. Lenders want to ensure that you can repay the loan. Therefore, some lenders may approve businesses with higher annual revenues.

Business Line of Credit vs. Loan

The business line of credit is revolving and allows businesses to withdraw funds whenever needed. The only condition is that the credit limit should not be exceeded. It is certainly useful for small businesses as it provides them with the opportunity to cover short-term needs. On the other hand, a business loan is a lump sum amount of money that is given to businesses at fixed interest rates. You will have a fixed timeline to repay the loan. Loan payments even start immediately, irrespective of the fact that the businesses have utilized it or not.

The business line of credit may also have limitations on the amount that can be borrowed. Secured lines of credit or higher amounts, the businesses will even have to provide collaterals.

Another significant difference is the way in which the business line of credit and loans can be used. Loans can be used for fixed uses, such as buying new assets or new equipment. On the contrary, businesses will have the flexibility with a business line of credit. It will allow you to decide where you want to spend the money.

Is Business LOC Right for You?

Your business should meet specific requirements to determine which credit lines are ideal. It may be a good fit if it meets the below-mentioned criteria:   

• Your business is in need of extra cash flow. 
• You are experiencing seasonal conditions and fluctuations in the industry.  
• You had to increase short-term expenses because of specific reasons.
• You want easy access to extra funds or have customers who delay payments for more than 30 days.

A business line of credit may provide flexibility. You can opt for it if you meet the above conditions or can even consider it if you do not have any specific criteria in mind. You should note that business credit lines come with varied interest rates. The fees can add up to the money, making it difficult for businesses to qualify. You should consider all the conditions before seeking a business line of credit and apply for it accordingly. Compare the rates different lenders are offering and choose the one that fits your requirements. Analyze the condition of your business carefully to make the right decision.