Business Line of Credit

Business Line of Credit

A Business Line of Credit is a flexible and revolving loan, from a bank or financial institution, which allows access to a fixed amount of capital to meet short term needs of the business. It is one of the tools which can be used to finance short-term working capital requirements. It is somewhat similar to credit cards because it offers the defined amount of money to which one can access as and when needed and then repay immediately or over a predetermined period.

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How does it work?

In the Business Line of Credit, the business receives access to a certain amount of funds to use as and when required. The monthly statement of Line of Credit reflects payment and interest. The interest is charged only on the fund used and not on the total amount of the loan. Once it is repaid, the credit limit will be available to be accessed again when needed. The payment schedule can be either weekly or monthly. In addition to the interest charges, certain annual fees are also imposed on Line of Credit. If it is frequently accessed by the firm, transaction fees can also be applied.

Types of Business Line of Credit:

  1. Secured Business Line of Credit: This requires the business to put specific assets as collateral to secure the line. As it is a short-term liability, lenders ask for short-term assets as collateral such as account receivables, inventory, etc.  If the borrower is unable to repay, the lender will assume the ownership of the collateral and liquidate it to pay the balance. A secured business line of credit will result in lower risk and so that it may have better terms. The interest rates might be lower and the repayment terms will be flexible.
  1. Unsecured Business Line of Credit: This does not require the business to pledge specific assets as collateral. Though, a personal guarantee is likely to be required. As there is no specified collateral tied to this type, the firm will require a stronger credit profile and positive business track record to have access to such a facility. In the case of this type of line of credit, the risk will be higher and the interest rates might be higher. There might also be maintenance fees.

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How can a firm apply for a Line of Credit?

Applying for a Business Line of Credit includes the following steps:

  • Find out whether the firm is qualified for Line of Credit, considering factors like credit score, revenue, company history, etc.
  • Compare various options to choose the best among them. These options include traditional bank lines of credit, online lender business line of credit, and business credit lines from credit unions.
  • Collect the information about the minimum requirements for this credit option.
  • Calculate the total cost including interest rates and fees.
  • Gather all the required financial documents and then apply for a Line of Credit. These documents include:
      1. Personal information
      2. Bank statements
      3. Financial statements
      4. Information about other stakeholders
      5. Legal documents
      6. Debt schedule
      7. Tax returns

Bottom Line:

Business Line of Credit is a financial product that is neither so good nor so bad. In fact, it depends on how it is used. Excessive borrowings against LOC can put the borrower in financial trouble whereas, it can be a cost-effective solution if used wisely. The borrowers are required to pay attention to its terms carefully.

Author: Hetvi Shah

About the Author: Hetvi is a BBA(Finance) graduate. She is currently pursuing an MBA with Finance specialization. She has a keen interest in Financial Market, Financial Management, and Financial Analysis.

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