Does my business need a line of credit?

A line of credit, sometimes called revolving debt, enables a company to draw against a pool of money as it needs to. That line of credit is invaluable for protecting your business from emergencies and stalled cash flow, because it extends the cash available in the business checking account to the upper limit of the loan contract. Essentially, the line of credit is assurance by a bank that as long as your company is financially healthy, it can borrow money whenever it needs to.

This form of short-term borrowing is an excellent way to establish a relationship with a bank and demonstrate the creditworthiness of your business—especially if you have but don’t use the line of credit. Moreover, by virtue of having this relationship, your banker can become a sort of silent partner, giving you business operation advice as well as money.

You’ll find many variables in a line of credit, such as the period of time (short or intermediate), whether it is renewable or nonrenewable, and whether it has a fixed or fluctuating rate of interest.

A short-term line of credit typically is 60 to 120 days, whereas an intermediate-term line may be as short as one year or as long as three. You’re most likely to want the line of credit to purchase inventory and to pay operating costs—not to purchase equipment or real estate. The Small Business Administration offers qualified small businesses CAP Lines loans to meet their short-term and cyclical working-capital needs. The five programs are called Seasonal Line, Contract Line, Builders Line, Standard Asset-Based Line, and Small Asset-Based Line. For more information, visit www.sba.gov/financing/fr7aloan.html.

To negotiate a credit line with your bank, prepare to hand over your current financial statements, latest tax returns, and a statement of projected cash flow.

What collateral will you use to secure your loan? You’ll need more than the assets you may be purchasing with it, such as the company’s accounts receivable, equipment, and real estate. The loan agreement and related documents will be designed to ensure that your loan payments are on time and have priority over non-critical expenses, dividends and employee bonuses.

This is a key point for avoiding confusion and resentment over what your bank is willing to do for you. Some small business owners may think that the loan officer does not understand their business requirements. At the same time, the loan officer may not think that the borrower is making realistic projections for anticipated cash flow, profitability, and the like.

As loans go, banks tend to view line-of-credit loans as low risk, so they carry the lowest interest rate. The bank may reserve the right to cancel the loan if it thinks your business is in jeopardy. You’ll make interest payments monthly, regardless of when you expect to pay off the principal. For an annual fee, most banks will allow one-year lines of credit to renew almost automatically. However, they may require the credit line to be fully paid off for between seven and 30 days each contract year.

Richard Strug
Greater Princeton Area SCORE (Chapter 631)
Serving Mercer and Middlesex Counties