Business Credit Lines

Finance Your Working Capitals Needs With Business Credit Lines

Using a line of credit for a business is the best way for the majority of companies to finance their working capital needs.  Below is an outline of how a line of credit works and how to qualify for a line of credit with a bank.

A line of credit can be compared to a giant credit card for your business.  When you need money for short term working capital, you simply call your bank and draw on your line of credit.  Once the short term need is paid off, you simply pay back what you borrowed to meet the need.  The interest rate is usually based on the Prime Lending Rate and is an inexpensive way to fund your business.  A well managed line of credit is a great tool for a business.

There are, however, several drawbacks to a convention line of credit.  The first problem is that they are usually not big enough to help many businesses.  If you are an established and profitable business with a growth rate of 10% or less per year, they work great.  If you have higher growth or are not yet an established and well capitalized business, they can become difficult to manage. 

Often times they are used for expenses other than short term capital needs.  If that occurs, it is difficult to pay them off for the required clean up period (a zero balance on the line for 30 consecutive days).  Also, since most of your collateral is tied up to secure the line of credit, there are not many other options to borrow additional money for new opportunities.  Also, line of credit is a backward looking product, meaning that it looks at what you did in prior years to establish how much you can borrow.  In a high growth mode, you typically will not have enough cash availability to meet the opportunity with a line of credit.

To qualify for a line of credit, each bank has their own credit criteria to approve the line and the amount.  The borrower typically submits business financial information along with personal financial information for the bank to make the credit decision and the bank can take from a few days to a few weeks to make a credit decision.  The old adage that says the best time to apply for a line of credit is when you do not need a line of credit holds true.

The best circumstance is that the bank looks at the equity in the business and uses the accounts receivable balance as a benchmark to set the line.  Typically a bank will use 65% to 80% of the prior year receivables balance to set the credit limit and borrowing percentage. 

Most banks however simply look at the personal credit score of the borrower and the value of the equity in their home or other real estate and set the line at a fixed amount based on those numbers.  The type of industry that you operate also determines the amount that you can borrow.  If you are in the printing industry, you have a higher debt to worth ratio because of the cost of the machinery needed to run your business.  This debt reduces the amount you can borrow on a line of credit.

It is also good to look at several lending options at the same time with a mix of both large and smaller banks.  Each has certain advantages and disadvantages over the other.

If you determine that a line of credit is not a good fit for your business or you do not qualify for the size line of credit that you need to run your business, there are several options in the marketplace.  A good next step is to look at a community bank that offers receivables based lending programs. These are cost effective programs that allows a business to match their sales to their cash needs by allowing instant access to cash from invoicing within the structure of a managed line of credit.

Whether you use a convention line of credit or one of the receivables based lines of credit, it is important to monitor and manage the credit facility to get the maximum advantages out of the money.