What is a Line of Credit in Business Financing?

Business Financing Line of Credit; What is it and How Can it Help Your Business?

A line of credit can provide businesses with a flexible business financing option to meet unexpected gaps in income or to take advantage of a time-sensitive strategic opportunity. 

So how does a line of credit work and when is the best time to get one?

What is a Line of Credit? 

A line of credit (LOC) is a flexible business financing option that businesses can get from banks and financial institutions up to a pre-agreed amount. The easiest way to understand a line of credit is to think of a credit card with a borrowing limit. 

Users can borrow as much as they need when they need it up to that limit, only paying interest on the amount that is borrowed rather than the entire amount that is available, although a monthly/quarterly maintenance fee will also be charged to maintain the line of credit.

In this sense, a line of credit is a set amount of money that you are given access to by a lender which can either be paid back immediately after being borrowed or over an agreed period of time. This way, when unexpected expenses arise or when an investment opportunity appears that your business is not able to easily pay for, a line of credit may provide the necessary funds to keep everything moving smoothly.

Why do businesses use a Line of Credit? 

A line of credit gives businesses a range of benefits that aren’t offered by standard asset-based loans. When you get a standard asset-based (secured) loan, after going through the application process you then receive one lump sum of money that starts accumulating interest as soon as you receive it rather than when you actually need to use it. 

A line of credit on the other hand overcomes this by giving you much more flexibility regarding how you access your credit. By setting up a line of credit with a lender, instead of simply being given a sum of money that instantly generates interest, you can instead access your credit line when it suits you. This also overcomes the hassle and waiting times related to regularly applying for new loans every few months as a line of credit can be continually maintained, saving time and streamlining the process.

Many different types of lines of credit are also unsecured, meaning that your interest rates along with your likelihood of approval are based solely on your credit score without the need to offer collateral. While they may not be the right option for securing a substantial amount of money for a one-time loan, they do offer a low-risk, flexible, and regular option for securing business financing to ensure that regular business expenses can be met.  

How does a line of credit help a business?

For businesses who are adapting to a changing environment, experiencing a growth phase in their development, or are facing uneven cash flow, a line of credit provides easy access to funds to cover basic business needs that ensure the health of the business. This may be for inventory purchases that are vital to keep the business going or to help fund a project whose expenses are difficult to gauge beforehand.

A great example is to consider a self-employed professional who may experience an unexpected delay between completing their work and getting paid by their customer. This interruption to their income is going to affect their cash flow, where they either won’t have the available funds to reinvest in their business, pay bills, or purchase inventory for a time or will have to rely on credit cards to overcome the lack of available funds. 

A line of credit, while similar in principle to a credit card, generally offers businesses better interest rates along with a more flexible repayment schedule to help reduce related fees and provide greater peace of mind.

Is a Line of Credit right for my business? 

A line of credit may be an effective option for you and your business if you are expecting regular issues regarding your cash flow that will impact your ability to meet business needs and invest in growth areas, especially when the amount of required funding is not known beforehand and where flexibility is a priority.

Some vendors also may not accept credit cards and instead require cash deposits, meaning that a line of credit will be more effective than your business’s credit card.

What you need to know about a line of credit

While a line of credit can be extremely useful, it is not simply “free” money and adhering to the terms and conditions of the loan are important, like with any other loan. Part of this means understanding how interest is calculated on the money that you borrow, since this may be different than a traditional loan due to the flexible repayment schedule.

While lines of credit are on average cheaper than using a credit card, they can be more expensive than a traditional asset-based loan, so if you know the exact amount that you need to borrow for a one-time expense, a secured loan might serve you better. If, however, you are not sure of how much you need to borrow and may need to borrow on a regular basis, then opening a line of credit will serve you well.

It is also important to know that more times than not, the interest generated on a line of credit will not be tax-deductible.

If opening a line of credit is the best option for you and your business to ensure that you have access to regular funding that will keep your business moving forward, then you can start the application process on our website at Intrepid Finance.