How to use a business line of credit?

When used properly a business line of credit can be a great tool for any small business to utilize. However, like many financial products, a business line of credit can be a disaster when used incorrectly. Here are a few key ideas to keep in mind when using a business line of credit.

Cashflow

The main use case for using a business line of credit is to keep your cash flow in check. While cash flow is a fairly basic financial concept, in theory, it can be difficult to manage in practice. Because your business’ expenses will stay consistent and your income will likely vary, a business line of credit can be used to supplement the inconsistency. Think of using it as using a loan for a rainy day.

Short Term Usage

Only use a business line of credit on short term purchases you know your business can repay. You would never purchase a new car on a credit card because the cost would be too high, and your repayment would be uncertain in the future– the same logic applies when using a credit line for your business. Make sure you are able to repay the loan shortly. Avoiding this can cause a myriad of debt traps that potentially put your business under.

Revolving Credit

Unlike most collateral loans, a business line of credit (a non-secure loan) allows borrowers to replenish their credit limit to the set amount once a portion of the borrowed money has been repaid. This is the same way a credit card works. If a credit limit was issued to you at $10,000, you borrowed $3,000 and repaid it. You are still eligible to borrow up to $10,000 once you have repaid the $3,000 debt. This idea of a revolving credit makes it easier for businesses to not only manage their cashflow but also to build an even better safety net in the event of an emergency.

Minimum Interest

It is important to understand how interest is calculated on a business line of credit. When you get approved for a line of credit, interest is only calculated on the portion of the loan that was spent as opposed to the entire amount. This is one of the major incentives for business owners to use their line of credit. The advantage here can result in a lot of savings for business owners. Given the previous example of earning a $10,000 approved line of credit, if a business owner spends $3,000, they would be charged interest on that amount only unlike other loans that would charge interest on the entire approved amount of $10,000 which can be significantly greater than what your business needs.

Be smart when spending borrowed money and only spend what you can afford in the short term. Use your business’ line of credit to keep your cash flow positive and stay prepared for when emergencies occur. Stay lean and consider using a business line of credit as a flexible way to grow your business and keep things consistent.