Access to cash via a line of credit is an important safety net for a small business. Although there are various types of credit lines available, it is the flexibility it provides that makes it so popular among small business owners.
A line of credit is more like cash on demand for a set amount. You can draw funds up to the credit limit set when your company needs it, and you only pay interest on the funds you withdraw. Best of all, every dollar of principle you pay back becomes available for the company to use again.
The important thing to remember is credit lines for businesses have received an overhaul in the past several years. No longer is a credit line being issued just by banks down the road. Today, there are completely different lines of credit issued to businesses from alternative lenders rather than by banks alone. In addition, small business owners can also get credit lines secured by specific types of collateral such as equipment and accounts receivables.
Here’s how I’ve learned to think about credit lines for business by following three simple rules.
Rule 1: Diversify your access to credit lines
When you rely on one bank or one type of credit line as the sole source of funding it may put your company at risk. When there is no backup plan if the company loses access to credit it can devastate a small operation. “A few years ago, losing a line of credit was a crisis - today, it's the new normal, ” says Marilyn Landis, a board member of the National Small Business Association in Washington, D.C.
Ask yourself right now what you’ll do if your existing line of credit gets shut down or drastically reduced tomorrow. To combat this, you need to diversify your access to credit lines through banks and alternative lenders. Remember, the credit lines your company has access to will be there when you need it, and you don’t have to use it or pay for it if you don’t. The National Federation of Independent Businesses says, “Think of it as an insurance policy that never needs to be paid until you need it.”
Rule 2: Use your credit line for what it’s good for
Recognize that credit lines provide an advantage over regular business loans. You only pay interest and fees on the portion of funds you use. If your credit line is for $20k and you don’t withdraw any funds, you won’t have any interest to pay. The entire $20k is available for the business to use but you only make payments on the money you’ve actually used.
The fact is a credit line for a business is a much more affordable option to fund short-term finance needs, like buying inventory, paying business expenses, or purchasing new equipment compared to applying for a business loan.
Rule 3: Practice Self-Discipline
Stay on top of your payments when it comes to paying back the funds you used on your credit lines. The use of credit lines in the company’s name provides the business an opportunity to establish a business credit rating – which can be very valuable for future financing. Although credit lines provide many benefits, their downside is accumulating debt which can lead to costly interest in the long term. While debt can definitely be a useful tool for certain aspects of a business, business owners need to make sure their debt is working for them and not against them.
On a final note, it’s essential to understand that credit lines for businesses are constantly evolving and changing. Sometimes unexpectedly. That doesn’t mean you need to go along with every funding option. Do your research and outweigh the pros and cons of each credit line product. Develop a diversity of access to credit lines for your business, and leave the anxiety and fear behind.