A business line of credit can be a handy tool for small businesses. Not only does it offer you the flexibility to get through financially sticky times, but it’s borrowing power is much more forgiving than a traditional business loan. In this article, we’ll walk you through everything you need to know about a business line of credit, including the best things it can do for your small business.
How a Business Line of Credit Works
How does a business line of credit work? Well, a business line of credit is actually more like a credit card than a loan – hence a “line of credit.” Firstly, it’s a revolving loan, meaning you can borrow from and repay the loan as you please, as long as you don’t exceed your credit limit. You’ll also need to pay interest on whatever portion of the loan you’ve borrowed with each payment, just like a credit card.
There are two different types of business lines of credit. The first is a secured line of credit, and the second is an unsecured line of credit. The main difference between an unsecured line of credit and a secured line of credit is collateral. An unsecured line will not require anything to be pledged, while a secured line of credit will.
There are a few secondary differences between unsecured and secured lines of credit, too. Some of them include:
- Secured lines of credit can cover larger amounts
- Unsecured lines may have higher interest rates
- Unsecured lines require better initial credit
- Since secured lines are filed against collateral, you don’t always need a perfect track record
How to Qualify
How does a business line of credit work when it comes to qualification? Like with any loan, you need to show a good track record to qualify for a business line of credit. Just how good that track record needs to be depends on whether you’re applying for a secured or unsecured line of credit, as we said above. Either way, you won’t succeed without records that show your business is making consistent profits.
As you might expect, when you apply for a business line of credit, you’ll need proof showing that your business has been operating successfully. Some of the documents and records you can use as proof include:
- Several months of bank statements
- Tax returns
- Business-related financial documents
- Evidence of a business bank account in good standing
If you’re wondering how to get a business line of credit for a new business, the answer is that, depending on how new it is, you probably can’t unless you have success with another small business to prove your track record. If you don’t have that, you can always search for a bank or entity that will be more lenient in exchange for collateral.
What This Means for Your Small Business
How does a business line of credit work for your small business? Well, as you might expect, it gives you many of the same benefits as a credit card, just on a larger scale. There is no single best way to use a small business line of credit, as you can use it for virtually anything as long as you pay it back and keep the line of credit healthy.
However, there are several ways that small businesses consistently use their line of credit for their benefit. Some of these best uses include:
- Covering business upgrades to improve your small business
- Repairing or upgrading broken equipment
- Evening out business expenses during slow seasons
- Helping your business adapt to unexpected occurrences or events
Not only that, but don’t forget that a business line of credit helps your business (and yourself) build credit, too. How does a line of credit for business work for you? By creating that good credit history with an line of credit, you might qualify for bigger and better loans to help expand your business in the future.
Small Business Loan vs. Business Line of Credit
While you might think that business lines of credit are very similar to small business loans, they’re distinctly different options – especially from a lender’s perspective. The main difference between these two options is what the bank or lender looks at during the approval process.
Essentially, a small business loan, such as an SBA loan, concerns the revenue of your business the moment you apply for the loan. But how does a line of credit work for a business? A new business line of credit concerns your business’ revenue today as well as its profitability in the future.
Tips to Manage Your Business Line of Credit
As with any financial tool, the usefulness of a business line of credit entirely depends on how you use it. While business lines of credit can be incredibly helpful if you manage them properly, they can just as quickly bring ruin to someone who isn’t careful with their money management.
Firstly, business lines of credit are flexible, but they can come with a host of fees if you’re not careful. As these fees can vary from lender to lender, you’ll need to be careful to read any fine print before agreeing to anything. Just because a bank offers a low business line of credit interest rates doesn’t mean that the end price will be lower than another, thanks to these fees.
Your final key to success is resisting the urge to use your business line of credit for superfluous expenses. For many people, having so much borrowing power available on-demand can be too much temptation, and the potential for abusing this is real. To give yourself the best chance of success, be sure to reserve your LoC for approved business expenses only.
In the end, a business line of credit can be an extremely useful tool for any small business, but how helpful it can be depends on how you use it. If you make sure to use your business line of credit responsibly (aka, you don’t rely on it -you just use it as a safety blanket or a resource for upgrading your business), it can be a tool that can really take your small business to the next level. Speak with a ROK Business Financing Advisor today to learn how you can get a line of credit for your business.