Credit Explained ABout Business Line

There are a number of ways to deal with the inconsistent revenue and costs associated with running your small business, and one of the best options is a business line of credit. A business line of credit is a flexible, often low-cost way to cover short-term financing needs such as purchasing inventory and making on-time payroll.

How does a business line of credit work?

A line of credit, or revolving line of credit, is a flexible loan option for businesses. Businesses are allocated a specified maximum amount of capital available to them through a lender based off certain factors such as current cash flow and business credit rating.

The business then decides when, if, and how they would like to use that capital. Interest will be charged only when you decide to pull money from the line. You will have a specified repayment period, but, like a credit card, there is no penalty for paying early (in fact, it is encouraged).

Although interest is only charged once you use the line, there may be a monthly maintenance fee for letting your line of credit sit unused. Check with your bank or lender to see if that is the case for any line of credit you are considering.

What is a secured vs. unsecured line?

A secured line of credit is a line in which the borrower puts up collateral as a security deposit on the line of credit. An unsecured line does not require any collateral assets.

Secured lines are often preferred over unsecured lines by both lenders and borrowers. The lender is taking on less risk, so they will usually grant a higher credit maximum at a lower rate for secured lines. New businesses or businesses with poor business credit might only qualify for a secured line of credit because of the inherently higher risk.

Unsecured lines of credit are more expensive because the lender assumes higher risk. Credit cards are a type of unsecured line of credit. Businesses with many years under their belts and stellar business credit are more likely to qualify for unsecured lines at reasonable rates.

What are lines of credit typically used for (and not used for)?

Lines of credit are great for many situations. Here are a few examples:

  • Your business has seasonal fluctuations — perhaps your sales take a dip in the summer. A line of credit will help during the periods of low sales.
  • Your clients take 30 days or longer to pay you for products or services you provide. You might need a line of credit to cover the interim time until you are paid.
  • Your product requires expensive materials — you may need a line of credit to cover the expenses while you build and sell your product.
  • You have the opportunity to receive a discount if you pay a particular bill early — if the resulting discount is significant, you can cover the bill with your line of credit while you wait for cash flow to catch up.

The uses of a business line of credit really can extend far beyond these to touch all businesses. A line of credit, however, is a form of short-term financing, so avoid using your line of credit for long-term expenses.

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