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How to Use a Business Line of Credit?
Most businesses have access to a line of credit. Proper use and management of this line of credit can be the difference between a successful business and a business that fails. But what does proper use and management entail?
One of the best uses for a business line of credit is to smooth cash flow. While your expenses are fairly steady from month to month, many businesses are cyclical, meaning they have seasons of higher revenue and seasons of lower revenue. During seasons of lower revenue, expenses may even exceed revenues. Ideally, a business will have enough savings to cover the extra costs, but this is not always possible (especially for new businesses that have not had time to accumulate a healthy savings account).
When revenues dip, a line of credit allows owners and managers to maintain normal business operations until the season changes, the next big contract comes in, or a marketing campaign generates interest in a new offering. Unlike other types of loans, lines of credit are not designated for any particular purpose, so management can use the funds to cover day to day expenses or unique situations for which a traditional loan may not be available. Because they are short term, they can (and should) be paid back as soon as revenues increase, keeping interest costs to a minimum.
A business line of credit may also be used for investing in the business’s growth. While traditional loans may be an option for purchasing an expensive new piece of equipment, they generally do not cover the expense of hiring new employees in time to train them before a seasonal rush. For new businesses, a line of credit can also be a great way to build a good credit history so that when it is time to expand, more traditional types of loans will be available at better interest rates.
Whatever you use your line of credit for, it is important to manage it wisely. As with any other loan, the funds must be paid back. While there is more flexibility with a line of credit than with other types of loans, the concept of debt is unchanged. Do not draw on a line of credit if you do not have a reasonable expectation of increased revenue in the future, either from an upcoming seasonal business cycle (such as the Christmas shopping season or summer break) or as the investment you made with the funds pays off.
A business line of credit can provide the funding to keep a business operating through slow seasons or growing toward its full potential. It is an effective tool that, when used wisely, can propel your business to the next level. If used improperly, however, the results can be disastrous. Understand your business’s revenues and expenses and use the line of credit to cover short term discrepancies between the two, and your line of credit just might be one of the most useful tools in your briefcase!
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