Business Line of Credit – explained in simple terms

Business Line of Credit – explained in simple terms

A business line of credit is a fantastic way for small businesses to get their hands on some extra cash when needed.

This article will explain how a business line of credit works, how to get one, and the pros and cons.

Business Line of Credit Overview

Wikipedia tells us that a bank extends a credit facility line to a business or individual customer, enabling the customer to draw on the facility when the customer needs funds.

It’s different from your stock standard bank loan that we all know, as you only pay interest in the amount you withdraw. The money is sitting there in your business account, and when you decide to use it, that’s when you commence paying interest. Think of it as a safety net. The money is there waiting for you for a rainy day. And, when it comes along, you can access it immediately. 

For example, if you have a business line of credit worth $60,000, you can use up to that amount. If you decide to buy a new piece of machinery for the business worth $30,000, then you only pay interest on that amount borrowed. It’s a safe feeling knowing that money is sitting in your account whenever you need it.

The beauty about a business line of credit is that the bank has no set term or expectations of paying this amount back within, saying 2 to 3 years. They are pretty happy for you to have it so long as you pay off the interest every month.

As a small business owner, you can decide to repay the line of credit when the business is good, and you start to see an improvement in cash flows. Plus, the bank won’t hassle you to repay it as long as you’re doing the right things in terms of interest repayments. I like to think of it as a credit card for your business without those insane interest rates. You will have to pay a set-up fee for this facility separate from your actual interest repayments. But, you might like to have a chat with the bank manager about reducing these as a goodwill gesture if you’ve been a long time customer.

The establishment fee is usually determined as a percentage of the loan amount and can be up to 0.70%. On top of this, there are monthly fees ( as banks typically do) of an account keeping fee. Watch out for these, and make sure you know all these nasty little surprises before committing to any line of credit.

Why a business would want a line of credit

As stated above, most businesses want a line of credit as a security blanket. It’s there in the account when times get tough, and there are cash flow issues. All businesses face challenging periods which is where they can draw on the line of credit. 

A line of credit can be used when times are good as well, and you need to react quickly to certain fluctuating market conditions. You might want to buy a piece of equipment or pay for an advertising campaign to promote a product that’s suddenly in vogue. Or you might want to start a social media campaign on Facebook or Instagram and need extra funds. It gives you the power to step up and do what you want to grow your business. Opening up new business opportunities should be the core focus of all business, and a line of credit makes this a possibility.

Basic requirements for getting a business line of credit

You will have to provide the bank with your financials and past tax records ( last two years ). They will want to assess your creditworthiness and determine whether or not you represent a risk. Some lenders will want to know your intentions for the funds and may require some security, such as the deeds to your home in the most extreme cases. Most likely, you would be able to secure the line of credit ( albeit small ) with proof of your past business performance and stability. They’ll want to know that your business is financially capable of repaying this money without you defaulting or going bankrupt. They’ll also check your credit history to make sure that there are no skeletons in the closet.

Pros of a business line of credit

  • The interest is higher than a long term loan but less than a credit card, so it sits nicely in the middle.
  • You have lots more flexibility as the funds are sitting in your account, waiting for you to access them when needed.
  • You only pay interest on the money you withdraw so that you can incorporate the interest payments in your planning.
  • There is no fixed term for a business line of credit, which makes money accessible to you for extended periods.
  • You can access the money easily and quickly via your bank account. In a couple of seconds, you have access to all these funds.
  • If cash flow is tight, you only need to repay the interest and not the principle.

Cons of a business line of credit

  • Having money there is tempting to use. Make sure you don’t overextend and use too much of your line of credit as interest repayments will add up over time.
  • The fees, charges and ongoing fees can be annoying, but hey, that’s business!
  • The paperwork required for this loan is more of a hassle than for other business loans, such as personal loans, business overdrafts and unsecured business loans. 
  • The amounts are less than other types of loans, which may restrict your business growth plans. If you feel that you will need more funds, different types of loans might be more suitable.

Borrowing money for the short term and need a line of credit or perhaps a short term business loan or even a bridging loan for your next property deal, the team at Sparrow Loans are here to help. We offer secured business loan approvals within 2 days!

About the author

Ulrika Lobo

Ulrika Lobo is the lending specialist at Sparrow Loans and has over ten years of experience in the commercial business loan space. Ulrika co-founded Sparrow Loans to provide Australian SMEs with a faster and easier way to access finance. Ulrika is responsible for managing the lending process from underwriting to execution and settlement and post-settlement support.