Here's an outline of the basics you'll want to know about your business line of credit and the best ways to use the money to meet your financial goals.
The 5 Best Practices for a Business Line of Credit
Making a credit line work for you requires an understanding of your company’s cash flow cycle and how best to apply the available funds to support operations during slow seasons. US Bank reports that 82% of small business failures can be attributed to poor handling of cash flow, so it’s important to review your finances and make projections for the future before applying. Think about these 5 things before taking out a line of credit:
1. Take Stock of Your Needs
A line of credit isn’t always the best choice to bring in the cash you need. If you’re facing a large one-time payment or planning an expensive purchase, a traditional loan will serve you better, and can often provide lower rates, especially if you qualify for a Small Business Administration (SBA) loan. Lines of credit typically cover up to $100,000, so if you're looking to borrow a larger amount, consider a term loan or other type of working capital loan.
If your company has consistent, predictable payments you know you can’t always make, a business line of credit can fill in the gaps until cash flow stabilizes or the seasonal peak cash flow comes in. Be sure to compare business line of credit providers when considering your overall needs, as there are many to choose from and each one has different pros, cons and requirements.
2. Identify Cash Flow Challenges
Recognizing where and when potential budget problems may arise can help you determine how to use a line of credit. Ask yourself:
- What times of year are the hardest?
- Where do I need extra money most often?
- What other payments am I making right now?
Common budget challenges for businesses include payroll, inventory, rent, utilities, and marketing. Go over past cash flow trends to find where a credit line can be most helpful. If you just want some extra cash to fall back on during the hard months or quarters, a credit line could be right for you. If your business is looking to grow with a large purchase or large marketing campaign, those cash flow issues might be better suited for other types of business loans.
3. Plan for Emergencies
It isn’t possible to anticipate every unexpected problem, but you can prepare yourself for the most likely emergencies your business might encounter. Whether it’s equipment failure, the need to replenish inventory in the middle of a holiday rush, or a sudden change in market conditions, a line of credit can be there to cover the costs. Your credit will need to be solid to qualify for a line of credit with good terms though, so plan ahead to be able to show your lenders that you're prepared to pay back the loan on time and you've thought ahead.
4. Spend Wisely
Although it may seem like obvious advice, it’s critical to exercise smart spending habits after qualifying for a credit line. Having a certain amount of money to draw from doesn’t mean you should take as much as you can. “Maxing out” the given amount leaves you no recourse for emergencies or growth opportunities. It’s important to know your needs, challenges, and potential emergency situations in advance so that you can plan to have enough credit available. If you see yourself making one large purchase and maxing out your credit line, you may pay less interest and have better repayment terms with another kind of loan.
5. Make Consistent Payments
Just like with a traditional loan, making timely payments on your credit line improves your overall business credit score and can increase your chances of qualifying for other (possibly larger) financial help in the future. You can also use your credit line to stay current with other payments, including invoices, credit cards, loans, and basic monthly obligations. Aim to pay down the balance on your credit line to zero at least once a year to maintain trust between your business and the lender. Adopting these best practices can help your business thrive when you're taking out a line of credit. Learn about some of the best small business loan lenders, and increase your chances of qualifying before you apply.
Is a Line of Credit Right For Your Business?
Instead of giving you a one-time lump sum of cash, like a term loan, a credit line provides a continual source of funds you can draw from at any time. This revolving form of loan is more flexible than a traditional loan and doesn’t run out when you need it most. Lenders require certain business, personal, and financial documentation to prove you can handle payments on whatever you borrow from the credit line, and you need proof of stable revenues in order to qualify. You'll only pay interest on the money you actually use, not on the full amount of your credit line. If you're looking for flexible funding and you're ready to plan accordingly, a line of credit might be the perfect funding answer for your business.