Should Your Business Have a Line of Credit?
What is a business line of credit? A business line of credit is a revolving facility that functions much like a credit card and/or a home equity line of credit. Lines vary in size from $10,000 to millions of dollars. They can be accessed by writing a check or online transfers, especially lines under $500,000 dollars. Larger lines are accessed by a phone call to your Banker.
How it Works
A line of credit ultimately supports your operating cash cycle. That cycle runs for one year. The time it takes to convert a sale or a service from billed to cash will determine how often the line of credit is outstanding.
Security for a line of credit is usually receivables and inventory. For lines under $500,000, you get a check book and you can access as needed. There is usually just a request for annual financial information. As the credit requests get larger, the bank needs more information, including monthly receivables, agings and inventory counts. In some cases the bank will secure a line of credit with a lien against your real estate.
For larger lines of credit, banks often require that the line be paid off for at least 30 days per year, to evidence that the line is being used for short-term cash flow needs throughout the operating cycle. The term for this is “clean up.”
The classic example of a “clean up” is a seasonal business such as a Christmas decoration wholesaler. This type of company needs the line to buy inventory in the late spring and summer months. The inventory is then sold in October, November and December. They then collect the receivables in January and February and should be cleaned up by April. The cycle starts again and the line is used to buy inventory.
Should My Business Have a Line of Credit?
The answer is yes. Even if you think you don’t need it, you’ll be prepared for unexpected circumstances when you will. Your banker will suggest it because he or she wants to make sure that you have this tool available when you really need it for short-term working capital.
Wholesaler, manufacturer, service, medical, accounting, — no matter your industry; it is important to have access to capital for a wide range of reasons. A line of credit can help support receivables, purchasing inventory on discount and/or in larger quantities, and – prevalent in the medical and legal fields — take advantage of discounts when you purchase large insurance policies.