Understanding a Business Line of Credit: How It Works & Best Options in 2023

• Explore how a business line of credit can be an effective financial tool for your business.

• Compare the advantages of secured and unsecured lines of credit to traditional loans & other financing options.

• Learn how to leverage your line of credit responsibly to unlock potential growth opportunities!

Exploring the Business Line of Credit Concept

A business line of credit is a powerful financial tool that allows you to access a set amount of working capital, draw funds as needed, and pay interest only on the borrowed amount. With the help of this flexibility, you can grow and manage your business assets more efficiently.

But now, you may be wondering how this gem works and the key components to consider while taking it. So, Let me explain to you all the important points:

How Does a Business Line of Credit Function?

A business line of credit is a type of lending in which the bank allows the business to take money at any time within a certain limit. 

Example: 

Ltd. opens a small new workshop for the production of jam. The business owners know that they will regularly need money for repairs, equipment purchases, and employee first payments. There are no free funds, so they turn to the bank. There they open a line of credit for the business: they get a credit line worth $250,000 for three years. 

During this time, the business can withdraw and spend the required amount on expenses. The business will not have to contact the bank every time and fill out a new application  – all tranches will be within the same line of credit. Moreover, interest will only be due on the outstanding balance.

Types of Business Lines of Credit

There are five types of business credit lines. Let’s talk about them in more detail.

Renewable

The bank approves a certain limit, and the business can take the necessary amounts at any time. After the business returns the entire debt, the limit is restored, and you can again take money within the original amount.

Example: 

The LLC has a line of credit for $100,000. The business took $30,000 to purchase a new machine, and the limit dropped to $70,000. But after the business bought the machine, made money on it, and returned the money, $100,000 became available to the business again.

Non-renewable

The bank approves the amount from which the business can withdraw money when required. After the business uses a loan, the limit is reduced by the amount of this loan and is not restored after the return of funds. 

Example: 

A bank credit line for $200,000 was opened for LLC. The founder issued three tranches of $50,000 each, that is, for $150,000. After the business returns the money, this limit will not return to its previous value.

Framework

The business enters into a single agreement with the bank to finance a specific goal or project; that is, it must tell what it needs the money for.

Example: 

LLC needs regular purchases of steel for the manufacture of weather vanes. The owner informs the bank that he needs to open a line of credit to purchase the material from which he makes weathervanes. The bank approves the limit, but it should be spent only for the agreed purposes.

On call

Similar to revolving: the limit is restored after the debt is repaid. But, unlike a revolving line of credit, the on-call limit is restored as the debt is repaid and not after the entire amount is returned.

Example: 

LLC gets access to a line of credit: bank approved $100,000 for two years. The business wants to develop a new packaging design for a line of sugar-free candies and purchase new equipment for its production. 

The business draws up the first tranche – $60,000. Accordingly, the limit is reduced to $40,000. Soon the business returns part of the debt – $30,000. This amount restores the limit and reaches $70,000. When the company makes another loan payment, the limit will again increase by that amount.

In addition to the types explained above, the business line of credit can be classified according to the method of collateral:

Unsecured line- funds are issued based on the credit history of the borrower;

Secured line- money is issued on the security of tangible property: real estate, securities, etc.

Comparing Business Lines of Credit to Other Financing Options

Before mindlessly taking a business line of credit, comparing it to other financial options that may be more flexible for your business is worthwhile. That options may include taking a traditional loan or acquiring a business credit card. You can decide based on various factors like monthly or annual fees, monthly payments, credit limits, interest rates, and usage flexibility.

Such a comparison will help you select the best business loan option for your business needs.

Business Line of Credit vs. Business Credit Card

Business credit cards are great for covering smaller expenses and for newer businesses, while lines of credit are ideal for more considerable expenses and more established businesses. Business credit cards can offer great 0% interest welcome rates, allowing most business owners and you to purchase without worrying about high-interest rates.

However, a business line of credit provides higher spending limits, flexibility in borrowing and repayment, and lower interest rates, making it a more advantageous option overall.

Business Line of Credit vs. Traditional Loans

If your business wants to fulfill its short-term financing needs, i.e., business purchases or day-to-day expenses, I recommend you take a business line of credit. However, if you need a loan to meet medium or long-term financing needs, I recommend you take a traditional bank loan. You should consider the intended use of cash when evaluating a company line of credit.

A small company loan, particularly a term loan, is better than a business line of credit if you’re trying to finance a significant, one-time, or long-term project.

Acquiring a Business Line of Credit

Ready to acquire a business line of credit? The process involves assessing your financial needs, understanding lender requirements, and preparing necessary documentation.

In this section, we’ll walk you through the steps to make the application process as smooth as possible.

Assessing Your Financial Needs

Before applying for a business line of credit, sit, relax, and take time to access the funds needed and determine the urgency. You can also use an online loan calculator to estimate lump sum payments and interest rates. Doing this lets you choose the type of business line of credit that best fits your business needs.

Be sure to consider factors such as positive cash flow, bank history, payment history, additional credit limit requirements, managing cash flow sources and reserves, and business revenue when evaluating your financial needs for a business line of credit.

Understanding Lender Requirements

Research and compare lenders, considering factors like time in business, annual revenue amount, personal credit score, and lender-specific qualifications. Remember that online lenders can provide more flexibility in their qualifications, with higher credit limits, potentially allowing startups and borrowers with bad credit to access a business line of credit.

Most lenders, on the other hand, have monthly fees and often require multiple years in business and a strong credit history.

Preparing Necessary Documentation

Being prepared in advance is always beneficial. Before applying, I suggest you gather the required documents, such as bank statements, personal credit scores of the owners, financial statements, tax, and returns. In addition, having personal and business tax returns, a business plan, or annual revenue projections will always be a plus point for you.

Ensuring that you have all the necessary documentation will make the application process flawless and increase your chances of securing the small business line of credit you need.

Top Business Line of Credit Providers

Now that you have a better understanding of business lines of credit let’s look at some of the top providers in the market. Whether you prefer traditional banks and credit unions or the convenience of online lenders, there’s an option out there to suit your needs.

From big banks to small local lenders, you can find a small business line of credit that fits your business.

Traditional Banks and Credit Unions

Traditional banks and credit unions offer competitive interest rates, allowing you to save money while accessing the funds you need to grow your business. However, they may have stricter requirements, such as strong revenue, minimum credit score and history, and collateral, to ensure the loan’s security.

Some top banks and credit unions offering these small business loans and lines of credit include Wells Fargo, Bank of America, and Chase.

Online Lenders

Online lenders provide more flexible requirements, streamlined application processes, and fewer fees than traditional banks and credit unions. However, they may charge higher interest rates and have lower credit limits.

Some top online lenders for business lines of credit include OnDeck, American Express Business Blueprint, Bluevine, Fundbox, and Lendio. These providers offer various credit business lines tailored to your business needs, ensuring you can access the funds you need to thrive.

Managing and Maximizing Your Business Line of Credit

Once you’ve secured a business line of credit, managing it effectively and maximizing its potential for business growth is crucial. This section will provide tips on responsible usage and timely repayments.

Strategies for leveraging your line of credit for growth opportunities include taking advantage of promotional offers, such as 0% APR for a certain period, or using your line of credit for growth opportunities.

Responsible Usage and Repayment

Having a business line of credit doesn’t mean that you start using it irresponsibly. It would be best if you used it with care. In addition, you can set automatic repayments so that you don’t face any issues of missing payments and can get a higher credit limit.

Leveraging Your Business Line of Credit for Growth

To take advantage of development opportunities, handle unforeseen expenses, and manage cash flow changes, strategically use your business line of credit. This strategy uses the flexible features of a business line of credit to support business growth, hire more employees, or make purchases of new equipment.

To prevent paying high-interest rates or fees, keep in mind to constantly be aware of your spending and make sure you can repay the line of credit on time.

Summary

Finally, a business line of credit can be a crucial tool for companies searching for adaptable financing choices to control cash flow, pay for unforeseen costs, or invest in expansion prospects.

By understanding the different types of business lines of credit, comparing them to other financing options, and navigating the application process, you can secure the funds you need to help your business thrive. Remember to use your business line of credit responsibly and leverage it strategically to maximize its potential for business growth. Now it’s time to take action – explore your options and find the perfect business line of credit for your needs today!