Loans aren’t the only way owners can fund their businesses. A line of credit is a financial option that your business can use to its advantage — and not just when money is tight. Here, we cover the basics of a line of credit and how we recommend using one to fund your business.
What is a line of credit?
A line of credit is a flexible loan that works similarly to a credit card. A line of credit is a predefined amount of money you can draw down on whenever you like and then repay immediately. With a line of credit, you’ll only pay interest on the amount you are currently borrowing.
Unlike a credit card, you can transfer the funds into your bank account without making a purchase. This makes a line of credit much more flexible for small business owners.
You can use a line of credit for:
- Providing instant access to funds whenever you need it
- Covering expenses that are too small for a bank loan
- Funding projects that are hard to price or that fluctuate a lot
- Covering unexpected expenses or emergencies
- Providing stability during slow periods or the off-season
- Covering expenses while you wait on clients to pay large invoices
Why not just apply for a business loan?
Lines of credit benefit businesses as they provide more flexibility than an unsecured business loan. With a line of credit, your business can use the funding however you want. There’s no paperwork or approval needed for specific purchases, and you’ll have financing whenever you need it. While a line of credit provides flexibility, they aren’t ideal for funding large purchases.
Another benefit is that lines of credit are usually more flexible than a business loan. You can usually make additional payments without being penalized and your repayment is based on what you draw down rather than a set repayment based on the principle borrow.
What to consider before applying for a line of credit
Revolving or non-revolving credit
Banks and financial lenders offer revolving and non-revolving credit facilities. A non-revolving line of credit means once you’ve paid back what you owe, the amount of funds available does not replenish. Once you’ve paid off your line of credit, your account will be closed, or you’ll have to reapply for another line of credit.
A revolving line of credit, like a credit card, replenishes the pool of funds available.
Your return on investment
Like other types of lending, a line of credit isn’t free money. Before applying for a line of credit, you should consider how you will repay what you owe. Like credit cards, it can be tempting to spend your money on items that don’t necessarily improve your business. Make sure you know why you want a line of credit and what scenarios you’ll use it for, such as:
- Ordering seasonal stock ahead of time that you know will sell later on
- Paying extra staff to keep up with demand while you wait on large invoices to be processed
- Paying to set up events that will generate additional leads and sales (like Pop Up Shops or Expos)
- Emergencies like replacing essential pieces of equipment
Your budget
It may take time to see any return on investment from using your line of credit. However, you’ll need to make repayments on any funds you draw down right away. Make sure you have these repayments built into your budget.
Lines of credit usually come with a variable interest rate, meaning your repayments can fluctuate. You shouldn’t use a line of credit to make up for shortfalls in your business — like paying staff regularly or funding everyday supplies. If you can’t afford to make these monthly payments, your business may be running at a loss.
When is the best time to get a line of credit?
It’s always better to apply for a line of credit before you need it. Remember, you shouldn’t be funding large projects with a line of credit. However, if your business operates a seasonal business or has clients who sometimes take a long time to pay, a line of credit can help your business run more smoothly.
Like a credit card, lenders of revolving lines of credit can increase their borrowing capacity over time.
Talk to us today if you think a line of credit is right for your business. At ThinkCap, we have access to over 75 lenders, including banks and non-traditional lenders and can find a financial solution that works for your small business.
