Many businesses experience peaks and valleys during their existence. Small businesses in particular will experience periods when cash flow is limited, especially in the beginning phases of the business. So why does this happen? Let’s discuss the different reasons why this cash flow roller coaster may occur.
Cash Flow Shortages
Depending on the business, there may be different reasons for a shortage of cash flow. Some experience seasonal fluctuations. Businesses that deal with seasonal fluctuations have periods of high peaks in addition to seasons where their business is slower. Businesses in this type of scenario usually go through periods where their cash flow is negative in the slow months but positive when they are busy. Unfortunately, the business still needs to be operated during the low peak periods.
Some businesses may choose to spend more cash than they actually have. In some cases this cannot be helped. An example of this would be a business that has to stock up on its inventory. In this scenario they may have to order the inventory at a time when they are offered discounts to do so but may be experiencing low cash flow.
Whatever the reason is, this is a common issue that business owners face. A decision has to be made by the business owner on how to circumvent negative cash flow during these times. Many business owners seek financing of some sort during these times and choose the traditional option of applying for business loans while other seek alternative funding options such as revolving credit.
Using Revolving Credit
Using revolving credit is becoming a viable choice for business owners because it is a flexible method of borrowing cash for your business, specifically your small business. Revolving credit provides you with a credit limit that you can borrow against.
Using revolving credit has become a quick solution for business owners, and it differs from the traditional business loan, which has a number of fixed payments to pay the loan off. With revolving credit, the funds are borrowed as they are needed. It is a form of financing that you can continually tap into.
However, be aware that revolving credit does consist of interest and may have additional fees. This means that although a bank may charge you more, you only pay interest on the amount that you have taken out and not paid back. An example of this would be if you are approved for a line of credit of $75,000. That $75,000 stays in the bank account, and you take out what you need as you need it. So you will be required to pay back only what you use.
This type of funding is considered open-ended because you can access the funds as you need them. But you as the business owner must be disciplined. It is important that you use the funds for what you need them for and when you really need them.
Reasons To Use Revolving Credit
That being said, let’s discuss what you should use revolving credit for as a business. Most businesses use revolving credit as a short term solution to cash shortages. This concept is reiterated in an American Express Open Network article. However, it is a good solution to assist your business during low peaks and for business purposes. So let’s take a look at reasons you should use revolving credit.
Seasonal Fluctuations – During this type of business cycle, your company can experience expansions and low periods. This can happen due to busier times such as the holidays, times where manufacturing may have slower cycles of production, and sometimes due to inclement weather. Using revolving credit can help you during these slower periods to stay afloat and implement a system to maintain positive cash flow.
Day To Day Operations – During slower periods, using revolving credit can help with the day-to-day operations of your business. In essence, this will help you exist. It is not suggested that you use revolving credit year round for day-to-day operations but as a short term solution.
Vendor Payments – If you work with vendors to fulfill your clients’ requests, they will want to be paid. There is no way to get around that aspect of doing business. And it will not matter to them that you are dealing with a slow season. Tapping into your revolving credit line can be used in this scenario, and this is a good solution.
Inventory and Supplies – As a business, you need supplies and inventory to transact business. There may be times in your line of business where you will have to stock up on inventory. A lot of times there are better days to purchase inventory than others due to discounts. So you may be in a predicament where you will need inventory but have a shortage of cash flow. In this instance, it is a great example when you can and should use your revolving credit.
Applying For It
Now that you have a basic understanding of revolving credit, let’s discuss how you go about applying for it. What are the requirements? Well, because you are applying for credit, you have to be creditworthy, have income and a good credit score, and have the ability to show you can pay down the amount borrowed. As a business owner applying for a revolving line of credit, you may have to provide a(n)
- Income Statement
- Statement of Cash Flows
- Balance Sheet
Since you are applying for revolving credit for your business, your business credit will be reviewed, as well. Just be aware that such information may be an additional factor.
When To Apply
As a business owner, you should know your business. This includes the peaks and the valleys. So as you forecast and strategize, it’s always a good idea to plan ahead. So if you know your business is slow during the summer, then plan way ahead and apply for a revolving credit line well in advance.
If you can qualify for revolving credit, it sounds like the perfect marriage to any cash flow shortage. But as with everything dealing with your business, you must conduct your research from all sides. To help you, let’s review key features of revolving credit:
- Revolving credit is called open-ended credit because the length of the credit is not fixed (It is ongoing)
- No fixed monthly payments
- You pay an interest rate and a commitment fee (what assessed you for the credit limit)
- The line of credit is similar to small business credit cards
Now that you have all of the information you need, a word of caution is to be careful and diligent. Well, that’s actually two words! But you get the idea here.
Remember how we talked about discipline? While using revolving credit can be a simpler flexible solution for funding your business, you must use it responsibly. Set up parameters to your spending, and spend only for what you have designated the funds for. Pay back the cash used as quickly as you can, and monitor your statements closely.
Good luck as you move forward!