From time to time, your small business may face revenue swings, prompting you to borrow money to meet your short-term cash and working capital needs. One option is to secure a business line of credit. The Small Business Administration defines a line of credit as a loan given by a financial institution to finance short-term current capital needs, such as inventory purchases or operating expenses.
“A line of credit is a useful tool for businesses with regular expenses, like paying employees or restocking inventory,” said Jim Salmon, vice president of business services at Navy Federal Credit Union. “It can be tricky deciding whether a line of credit is the right tool for your company, so we help our business members weigh the pros and cons before making the financial decision that’s right for them.”
Below, Salmon outlines the pros and cons of a business line of credit.
- According to Salmon, the main benefit of a line of credit is that it acts as a safety net for your business. “It acts like working capital and makes funds available for your business while you wait for payments on accounts receivable,” he explained. “You can rest easy knowing your employees will get paid even with unpredictable, temporary cash flow slowdowns or problems.”
- A line of credit is also a means of leverage to help kick-start business growth. Says Salmon, “Having the funds for extra inventory for a seasonal push can be tough for a small business. The line of credit could permit for that additional purchase of stock and allow you to be more opportunistic.”
- A less obvious benefit is that it can strengthen your relationship with your financial institution. Making payments on time and abiding by the arrangements associated with its use shows viability of your company and character of management. Should you decide to expand your business, a strong relationship with your financial institution will help you gain future acquisitions faster.
- Salmon warns that a line of credit can be easy to misuse and “can get you into trouble.”
- “As a business owner,” he continued, “you want to monitor how much you access your credit line. Most are variably priced, meaning the rate can change quickly.”
- Salmon also points out that just like a credit card, you should make the required payment, or your rate could increase sharply. In addition, owners should be aware of any added requirements that might be associated with having access to the line. For example, quarterly accounts receivable reporting and financial requirements regarding liquidity and reporting are common. “Owners should ask themselves if they are ready and willing to commit to such oversight.
- Having a line of credit means there is on-record indication of how responsible you are with managing or mismanaging your money. “It will count in the grand scheme of potential credit and be incorporated in any future decisions with your financial institution,” Salmon explained.
If you’re interested in obtaining a line of credit for your business, talk to your financial institution about your options. Each has its own criteria for obtaining a line of credit, such as 2-year in business minimum or collateral. Salmon added that sometimes, “a small business is able to secure a line of credit with the collateral being the assets of the business or personal assets if need be.”
If your business doesn’t qualify, Salmon says there are other loan alternatives. For example, Navy Federal recommends a business credit card as a viable option for its members who need funds from time to time for small purchases or cash advances.
Follow Salmon’s advice above and talk to your financial institution to see if a business line of credit is right for you.