What is a Business Line of Credit?

How a working capital line of credit can help when funds are tight

All businesses experience occasions when cash flow can be tight. Accessing a business line of credit (also called a working capital line of credit) is a quick, flexible, and affordable way to manage your working capital.

A business line of credit is typically a “revolving” loan that you can use when needed, with a specific maximum amount. Unlike a term loan, you can borrow a portion of the maximum amount allowed, so you just use what you need when cash balances are tight. Once your cash balances begin to build back up, you can pay down your line of credit. When needed again, the funds are always available to you without going through another approval process. Most lines of credit require you to make a monthly interest payment based only on the amount you used. 

Common reasons small businesses use a business of credit include:

• Covering a timing gap between covering accounts payable and fixed expenses costs (payroll, rent, etc.) and the collection of accounts receivable.
• Company revenue growth leads to significant growth in accounts receivable and/or inventory.
• Taking advantage of early payment discounts with major vendors.
• Making a larger than normal inventory purchase due to supply chain challenges or bulk purchase discounts from suppliers.
• Evening out cash flow for seasonal businesses.

Typically, a working capital line of credit matures after one year and is reviewed and renewed annually. Rates are always priced with a variable rate tied to an index like the Prime Rate or SOFR. This type of financing is secured by your business assets, and your bank may monitor your borrowings on the line of credit to ensure balances do not exceed available collateral. 

Short-term lines of credit

In cases when the amount of money needed to bridge a gap is a one-time or short-term need, you can consider a short-term line of credit. This is commonly used to cover a one-time project like a remodel or large equipment installation or if your business needs to purchase multiple pieces of equipment over 6-12 months and would like to consolidate these purchases into a single loan. The short-term line of credit would be available as needed and would convert to a term loan at the end of the project.

Developing a relationship with your bank

By working with a bank that knows your business well, you can negotiate terms that work in your favor. Your banking professional will be able to assess if a business line of credit makes the most sense for your working capital needs and determine payback options that work within the seasonality, stability, or structure of your business.