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Business Credit, Finance & Accounting

Everything You Need to Know About a Revolving Line of Credit

Revolving Line of Credit

Updated on August 25, 2017.

 

So, What is a Revolving Line of Credit?

  • Definition: Revolving Lines of Credit are financial limits that are extended to customers for their use up to a set maximum amount.
  • How it works: This type of funding works similar to credit cards. Unlike traditional loans, you don’t have to use the entire amount offered to you at once. You can use the funds as you need them up to the amount offered.
  • Example:  If your business gets approved for a $25,000 small business line of credit, this means that your business can borrow a total of $25,000. But you don’t have to borrow all of that money at once! You can borrow $25,000 at once, or you can borrow any smaller amount (whether it’s $5,000, $10,000, or more) that you need. With a revolving line of credit, you pay back any money you borrow on a flexible basis. There is no fixed monthly payment that you have to make. For example, if you borrow $1,000 from your revolving line of credit, you can pay it back all at once with one payment the following month, or you can pay back $200 per month for 5 months (plus interest), or you can pay back $100 one month, $300 the next month, and $600 over the next three months, depending on your available cash flow. As long as you make your minimum payments and avoid taking on too much debt for your business to handle, a revolving line of credit can be an effective cash flow management tool for your business.

With a revolving line of credit, you pay back any money you borrow on a flexible basis. There is no fixed monthly payment that you have to make. For example, if you borrow $1,000 from your revolving line of credit, you can pay it back all at once with one payment the following month, or you can pay back $200 per month for 5 months (plus interest), or you can pay back $100 one month, $300 the next month, and $600 over the next three months, depending on your available cash flow. As long as you make your minimum payments and avoid taking on too much debt for your business to handle, a revolving line of credit can be an effective cash flow management tool for your business.

Small business owners might need to borrow money to help buy more inventory at a critical time, manage payroll, or pay the bills while waiting for payments to arrive from slow-paying customers. One of the best ways to borrow money as a small business owner is to get a small business loan or a revolving line of credit.

A revolving line of credit is an important tool for small business owners to keep their businesses’ operations going smoothly with the ups and downs of sales, seasonal changes and occasional cash flow shortages. Getting a revolving line of credit can also enable your business to pursue opportunities more quickly, even if you don’t have cash on hand available to invest. A revolving line of credit can be an important way to invest in your business’s growth.

Before you sign up for a revolving line of credit, it’s important to know more about how this business finance tool works, what it’s used for, and how you can get the best overall fit for your business needs.

How is a Revolving Line of Credit Different from a Small Business Credit Card?

There are some similarities between a revolving line of credit and a small business credit card. They are both “revolving” credit accounts – when you borrow money from your credit card, you are borrowing against a pre-approved credit limit. For example, you might have a limit of $12,000 on each credit card, and you cannot borrow anymore beyond that upper limit – in the same way, your revolving line of credit will have a limit on how much you can borrow. Also, just as with a credit card, a revolving line of credit requires you to pay off the money you borrow over time with a flexible monthly payment (as long as you meet the minimum payment each month).

But there are some important differences and advantages of a revolving line of credit versus credit card that can make it a better choice. One difference is that you don’t have to carry a physical plastic “card” as part of having a revolving line of credit. Another difference from a credit card is that you can borrow from your revolving line of credit for any reason and get the money into your business bank account directly. With a revolving line of credit, you don’t have to make a specific purchase transaction like you would with your credit card. For example, if you need to borrow some cash to make payroll next week, a revolving line of credit will put money in your bank account immediately; you don’t have to ask your employees to accept payment via credit card.

In this way, a revolving line of credit works kind of like a “cash advance” from a credit card, but without the high fees and high-interest rates. And that’s another area where a revolving line of credit can offer big advantages: a revolving line of credit often offers significantly lower fees than a credit card. This gives you the cash you need and allows you to save money on overall interest payments and bank fees. A revolving line of credit helps you keep more money to grow your business – and give less money to the banks!

How does a Revolving Line of Credit Compare to a Business Installment Loan?

A revolving line of credit is an “open-ended” credit line. That means that you have advance approval to borrow as much money as you want (within the limits of the credit agreement) without having to re-apply every time. This is another advantage of revolving lines of credit compared to traditional business loans, where you would have to go to the bank, talk to a loan manager, fill out an application, wait for your credit score to be checked, and on and on and on.

A revolving line of credit is faster and more flexible than a bank installment loan; you can get the cash you need quickly and stay focused on your business.

Another difference between revolving lines of credit and installment loans is that a revolving line of credit is usually used for short-term purchases and expenses. A revolving line of credit is typically used to help a small business manage the monthly ups and downs of running a business – paying bills, paying employees, dealing with cash flow shortages, or making short-term investments and improvements in the business. A revolving line of credit is intended for business owners to dip into frequently and pay back quickly. It helps your business manage any bumps in the road and keep moving forward.

A business loan is more of a long-term financial proposition. Business loans are typically used for bigger and more expensive investments in your business, such as new equipment, capital expenditures, or building a new facility. Unlike the more flexible arrangements of a revolving line of credit, business loans also have fixed payment terms and a specific date by which the loan must be paid in full. For example, if you get a business loan where you borrow $100,000 at 6 percent interest, the bank will require you to pay back that money within a certain number of years at a certain fixed payment per month.

A revolving line of credit or a longer-term business loan can each offer advantages for your business, depending on your needs and your financial goals. But it’s important to know the differences before you commit to any course of action as borrowing money is a fact of life for most small businesses. Sometimes you have to “spend money to make money,” and a revolving line of credit can help give your business steady access to cash when you need it most.

Looking for a revolving line of credit from Kabbage?
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Kabbage Team

Kabbage is here not only to provide access to the small business funding you need, but to also help you grow your business through free marketing tips, webinars, tools and more. Is there something you'd like us to cover or want to get your small business featured on our blog? Send us a note at content@kabbage.com.