SMALL AND LARGE businesses alike tend to run on cycles. Many of these cyclical disparities can be a result of a business’ seasonal operating schedules, fluctuations in the economy, and consumer buying patterns. These elements can cause the business in question to scramble at times to stay afloat financially. Other factors that may keep business owners up at night are payroll requirements, an overabundance of receivables, and the need for additional inventory or equipment. As a result, business owners commonly encounter difficulties in effectively managing their cash flow.
Any one of these scenarios can be particularly true of any small business start-up during their early phases of existence. One solution to overcome these obstacles is establishing a business line of credit.
Business Lines of Credit Explained
Not just for rainy days or times of trouble, a small business line of credit loan can actually help a small businesses grow and thrive. Designed as a type of loan to finance short-term working capital needs, a small business line of credit is administered by banks and other financial institutions to qualified businesses meeting certain minimum lending requirements. Banks will usually extend a secured line of credit to most start-up ventures. This usually means that a personal guarantee and/or collateral of some sort will be required to approve the line and the amount which is given. On the other hand, the lender in question may extend an unsecured line if the small business is capable of exhibiting minimum risk through consistent earnings and a positive cash flow over time.
Based on creditworthiness and comparable to the credit card model, small businesses are approved for a credit line with a pre-determined maximum withdraw mount. Once established, the business can utilize a revolving borrowing-and-repayment process during the term of the loan. This is the logic behind the line also known as a revolving line of credit.
Understanding the Terms of the Line
Many lines of credit are for a term of one year; however, there are always exceptions to this rule. Other things to think about are the applicable interest rates, repayment requirements, annual fees, and the documentation needed to get the line established. After the line has been established, it is always advisable to maintain an open line of communication with your banker. This step affords you the opportunity to learn about transitioning out of one line and into another (secured vs. unsecured), if applicable or desired. This communication also keeps you informed about the bank’s other lending products that may be available to you as a result of your payment history with your current line of credit.
And speaking of payment history, there is a plus in all of this beyond just having access to cash when needed. A solid history of timely payments over the course of a period of time also improves your creditworthiness and borrowing power with your lending institution. This is an important step because when the time does come where your business may need something more substantial than a credit line (such as a full-scale business loan or second round of financing for expansion purposes), you’ll be a more attractive candidate for that loan. The same is true with corporate credit cards and the accompanying payment history that goes with it too.
Of course, there is a large responsibility on your part in all of this as well. What if you are slow or inconsistent in your repayment of the line of credit? Well, your lender may then require you to pay down your line. The rule of thumb is that when you have not followed the as-agreed-upon payment schedule, even though the total amount of money borrowed may not be due for several more months, you may be asked to ramp up or even pay it off as a result of violating the terms of the loan.
The Path of Least Resistance
Many small business owners, especially in the early stages of their existence, always feel leveraged and collateralized to death. This is a normal feeling. The key is transitioning out of this process by letting your business’s track record speak for itself slowly over time. When thinking about seeking a first-time line of credit for your business (and subsequent approval), there are several things you can do to prepare in advance of that application process (or any application process for that matter). One way to accomplish this is to build credit early on.
Even if it may not affect your credit report or score, establishing accounts or relationships with outside entities through your business’s name is vital. The first steps would be to put everyday items such as business banking accounts, a safe deposit box, debit cards and even a small-balance credit in your company name. Other components that can be added would be mobile phones, monthly data plans and insurance coverage bearing your business’s name. These small alterations can provide excellent supporting documentation when applying with the lender. Finally, creating an invoicing system for receivables and also showcasing a history of payable incoming receipts with vendors simply adds to your application positives.
The goal here will be to start a running file of your business dealings; externally (vendors, etc.) and internally (banker, lender). With each transaction, and subsequently with each passing month of successful payments, your file with the bank will take shape and expand with sustaining credentials. This clean and well-documented file will pave the way for success with other banking and financing initiatives you may be planning. The line of credit can be the eventual cornerstone for those plans.
Although a revolving line of credit can be a major step in solving cash flow issues that may be currently present (or even impending), the aspect of establishing a stronger bond with your banker and lending institution through this process shouldn’t be overlooked or underestimated. A line of credit, once established, may stay in place indefinitely; however, the way in which you manage it will go to great lengths in determining future dealings with lenders.