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Business Credit, Finance & Accounting

What is a Business Line of Credit Used For?

Business Line of Credit

Due to the cyclical nature of businesses, you may need to borrow money to meet your business’s short-term needs or goals. One commonly used option to obtain these funds is by securing a business line of credit. A business line of credit can help with the ups and downs of business cycles.

What is a Business Line of Credit?

A business line of credit is defined as an arrangement between a financial institution, usually a bank, and a customer that establishes a maximum loan balance that the bank will permit the borrower to maintain. The borrower can draw down (withdraw funds) on the line of credit at any time, as long as he or she does not exceed the maximum set in the agreement.

The advantage of a Kabbage line of credit over a regular business loan is that the interest is based on what you borrow, and you only borrow however much you need. Meaning, you do not have to take the entire amount that you are approved for. You take what you need and payback on what you take. You can repeat this process as many times as you need to.

A business line of credit loan is a type of bank loan that is granted to help businesses finance a number of different things. In most cases, a line of credit is utilized to assist a company with short-term funding for basic day-to-day operations, such as meeting payroll, purchasing supplies, increasing working capital or getting extra inventory for a seasonal push. Many businesses — at one time or another — have cash flow problems. Cash flow issues can stem from a variety of reasons ranging from a large account falling behind in payments to a seasonal spike in sales. The fact is, even though you may be managing your cash flow smoothly at the moment, you can’t always predict the circumstances in which you’ll find yourself a few months from now. It’s possible that someday you’ll be stuck trying to pay your employees or vendors — without enough cash in the bank.

Successful day to day operations requires an uninterrupted supply of capital. While the best thing to do is save enough money to weather these storms, the next best thing (if you don’t have enough saved up at the moment) is to apply for a line of credit with a financial institution or bank. Applying while you are flushed with cash puts you in the best position with lenders—after all, we all know that banks are more eager to loan you money when you don’t need it, rather than when you desperately do. That’s where a business line of credit loans can fit comfortably into your financial picture. It is good to have a ready source of funding to keep your business running smoothly and profitably, day in and day out.

Why Should You Apply for a Business Line of Credit?

A few good reasons come to mind for any business to have a line of credit available. Every business needs to have some cash on hand. Sometimes you have it, sometimes you don’t. Wouldn’t it be nice to always have it when you need it? A line of credit will be there when you need it, and you don’t have to use it or pay for it if you don’t. If your business qualifies for a business line of credit, you can tap into the money any time you need help getting through shortages in cash flow. Having a line of credit readily available is also extremely useful when that really good opportunity or low inventory price presents itself, or when you need to offset anticipated seasonal dips in your sales. The extra cash can tide you over until your business is strong again. Note that a line of credit should NOT be used to bail a business out of a serious ongoing financial crisis; it should be thought of only as a safety net to tide the business over until accounts receivables come in. Lines of credit are meant to be used, paid off, then used again as necessary.

Although it is common to compare a line of credit versus credit card, the two funding options are quite different. A business line of credit loans does not come with hefty credit card fees. Did you know that most businesses first turn to credit cards and credit card cash advances for short-term funds? You can certainly tide your business over using corporate credit cards, but you will be paying some high rates and hefty fees. You want to avoid hefty credit card fees at all costs. You will never get that money back! Credit card rates will never be as favorable as a business line of credit. Although it is not a credit card, a business line of credit works like a revolving credit card but has no fixed payments and typically is based on an adjustable market-based interest rate. Check with your bank about your options since each financial institution will vary when it comes to its business line of credit. However, in most cases, the business owner can pay the full balance off at any time (or sometimes after six months) without worrying about a pre-payment penalty.

Having a business line of credit available will also give you peace of mindYou don’t need to anticipate cash flow issues to apply for a line of credit. Think of it as an insurance policy that never needs to be paid until you need it. You will sleep better at night knowing that if you ever come up short during the month you’ll always have money to fall back on for payroll or to pay bills.

So, What Should Business Lines of Credit Be Used For?

A business line of credit is a financial instrument typically used for an organization’s short-term working capital needs, such as inventory purchases, future project costs or company payroll. Lines of credit are mainly to help even out your cash flow. Terms are usually annual with an interest rate based on the prime rate plus one to three percent. Payments are interest-only on the amount you borrow.

One good thing to keep in mind is that typically, banks prefer to see that the line has been “rested” or paid down to a zero dollar balance at some point during the year. So don’t draw more than you think you’ll be able to repay within a short window of time. Credit lines can range from $10,000 to as high as $250,000 (at Kabbage), depending on your business needs.

Whether you are a start-up business or a growing business, at some point in time you can’t make payroll for the month. Making payroll is a critical piece of keeping your business running, and of course, it helps you keep the employees that you already have

Many situations come along in business and you can’t always predict if you are going to have to hire an additional employee for a sales spike, or not be able to pay the ones you have because someone hasn’t paid you. While every business should have a cash cushion available for times like these, sometimes the crisis lasts longer than the money does. Times like these are exactly when you should draw on your business line of credit.

Small businesses need inventory to get started, and they also need to anticipate future inventory needs. As the owner of a business, your success is measured by consistently being able to give your customers what they want exactly when they want it. Meeting that demand keeps you in business; going above and beyond helps you grow.

Loans in the form of a business line of credit are perfect for helping a business manage its inventory needs. While you may be good at estimating how much inventory you have and need monthly, it may be hard to pass up a great bargain or sale on a product that you will need later. If you don’t have money on hand, drawing on your credit line to purchase additional inventory (especially at a fire sale price) is a common practice. Once you sell that inventory and make a profit, you can repay your line of credit, and prepare to use it again when the need arises.

Since most small businesses are seasonal in nature, particularly those in the retail industry, you may need more inventory before you have made enough to pay for it. And being seasonal means that your sales generally are made in one (holidays) or two seasons of the year.  When you are just starting and have minimal cash flow, it is difficult to equalize your debt and income over a 12 month period, especially if you are starting with zero.

If your business makes most of its sales during the holiday season, you know that you will need to begin to purchase inventory well in advance of the holiday season. Unfortunately, this may not coincide with a time that your business is actually making money and you may not have made enough to pay for all that inventory. This is exactly when a business line of credit loan should be used! By having your line of credit open prior to the holiday season, would allow you to purchase a large amount of inventory to gear up for the holidays. It wouldn’t take long after the holiday season for you to pay off the line of credit with the sales proceeds from the holidays, and then prepare to start over again.

Many businesses utilize business line of credit loans to increase their working capital. Many financial institutions even have special working capital lines of credit available. Using this type of loan can help you take your business up a notch by bridging the gap between the tasks you need to do and the cash flow you need to get them done.

  • Working capital is defined as the difference between current assets and current liabilities.
    • This measures what is leftover once you subtract your current liabilities from your current assets, and can be a positive or negative amount.
  • Current assets are the most liquid of your assets, meaning cold hard cash or anything that can be quickly converted to cash.
  • Current liabilities are any obligations due within one year.

The working capital is what keeps your business working. It’s what you have available to pay your company’s current debts and represents the cushion or margin of protection you can give your short-term creditors. And, if you have enough of it, it is what funds growth. Most small businesses just don’t have enough of it!

If you don’t have enough of it, you are not alone. Many businesses draw on their business line of credit loan to enable them to get off the ground and grow. Lines of credit are a great way for businesses like yours to generate capital and start focusing on business growth. In order to grow your business, it is important to have capital on hand to cover costs like marketing, payroll and any other financial expenses that occur within your business. Positive working capital is required to ensure that your company is able to continue its operations and that it has sufficient funds to cover both short-term debt and upcoming operational expenses. The management of working capital involves managing inventories, accounts receivable and payable and cash.

A business line of credit is something that can help your business meet its needs with cash to spare.  As the old adage goes, you can’t make money without money! So, whether your business needs to purchase inventory, increase working capital or make this month’s payroll – business lines of credit loans are available for you!

Want to learn more about Kabbage’s Line of Credit?
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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.