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What is a small business line of credit? A small business line of credit is type of business loan that allows your business to draw against an approved predetermined credit limit (loan amount), as per your financing requirements instead of receiving a full amount like a term loan. A small business line of credit is a flexible financing tool that provides as much or as little capital as needed when required for whatever your business may need.
What is a small business line of credit?
A business line of credit (LOC) is a revolving loan that allows access to a fixed amount of capital, which can be used when needed to meet short-term business needs. A business line of credit is one of the tools a business can use to finance short-term working capital requirements, such as;
a. Purchasing inventory.
b. Repairing or purchasing business-critical equipment vs. equipment financing.
c. Financing a marketing campaign.
d. Bridging a seasonal cash flow gap.
A credit line allows you to borrow in increments, repay it and borrow again as long as the line remains open. Typically, you will be required to pay interest on borrowed balance while the line is open for borrowing, which makes it different from a conventional loan, which is repaid in fixed installments.
How Does a Small Business Line of Credit Work?
A small business line of credit (LOC) is an amount of money you can borrow from a bank or lender up to a limit. You can draw any amount from your credit line based on your needs, up to the maximum amount approved on the line. You’ll only pay interest on the amount you borrow. A line of credit provides borrowers quick access to the money “on demand.”
You will only pay interest when you borrow (withdrawal) from the line and once you repay those funds, that amount is again available for you to borrow. A small business line of credit offers flexibility to business owners. It’s up to you to choose when to use the money, pay it back and repeat, as long as you stick to the terms, including paying off what you borrow on time and in full.
Bank vs. Private Lenders for a Small Business Line of Credit – How many small business line of credit are there?
When it comes to a small business line of credit, there are two main sources. These are private traditional banks & credit unitions and private lending companies. Before choosing which type of lending works best for your business, it’s important to understand the differences between a bank and private lender.
While each provides money, there are some fundamental differences business owners should be aware. Banks are traditionally less expensive, but they are harder to work with and more difficult to get a loan approved with. Private lenders tend to be more flexible and responsive, but they are also more expensive in terms of interest rates.
- Lower Interest Rates – Less Expensive
- Cumbersome Approval Process – Including Financial History and Credit Audit
- Subject to Government Regulations
- Strict Loan Options Due to Regulations
- Higher Interest Rates – More Expensive
- Easier Approval Process
- Less Regulated – More Flexible
- More Customizable Loan Options
Uses of Lines of Credit for Businesses
A business line of credit is a very specific lending product designed to bridge the gap between a company’s buying and selling cycle. Lines of credit can be in the form of a secured or unsecured extension of credit, depending on each business’s unique financial make up. It is a powerful tool businesses can use to support their operating expenses, finance inventory or accounts receivables.
Ultimately, a line of credit can be a helpful tool for growing or seasonal businesses get to the next level.
Determine if your company is a good fit for a line of credit.
Companies that typically use a line of credit are those experiencing growth and need short-term financing to build inventory, hire, or finance accounts receivables. Mature companies or industries with seasonal sales cycles, such as retailers or wholesalers getting ready for their busy season may use a line of credit to purchase inventory.
Benefits of Using a Line of Credit
Many business owners prefer business lines of credit over small business loans or equipment financing. Here are some of the advantages of opening a business credit line.
1. Lower interest rate. While rates for credit lines are generally higher than conventional bank loans, they are still lower than credit card rates, small business loans or equipment financing options.
2. Improved cash-flow management. A small business line of credit can small businesses even out their cash flow for seasonal businesses like retailers or landscape & construction companies.
3. Make purchases too large for a credit card and too small for a loan. There may be times when you need to buy something such as equipment that is too expensive to put on a credit card but not enough for a conventional bank loan. A small business line of credit can be perfect for these scenarios as well as provide you the flexibility of repayment options.
4. Emergency funds. A line of credit is a good buffer in tough times.
5. Ability to repay and borrow again as needed. Unlike a conventional loan, credit lines let you pay off the balance as you go and continue to borrow again when the need arises.
Applying for a Small Business Line of Credit – Small business line of Credit Requirements
Like a conventional term loan, most lenders will want to see financial records and documents that demonstrate a track record of financial performance and creditworthiness. Traditional lenders like banks and credit unions will require some additional documentation online lenders might not require. Some of the basic information you’ll need to apply could include:
- Business License
- Tax Returns
- 3 to 6 months of bank statements
- Accountant prepared Year-End Financial Statements
A small business line of credit can be a valuable tool to fuel growth and fund other profit-generating initiatives. They offer the financial flexibility to cover gaps in normal cash cycles, can be used to harness resources to maintain year-round business operations for seasonal businesses, and can fund expenses that build value and amplify success in concert with other financial tools.
Other business financing methods to explore:
Equipment Financing & Equipment Leasing for Capital Equipment Purchases