Small businesses are always on the lookout for flexible solutions to help manage their cash flow and spark their growth. In such a tricky economic time, it can be difficult for newer entrepreneurs to find their way and take their business in the direction they planned to.
Small business loans have decreased for the eleventh consecutive quarter, while line of credit usage has continued to increase. This shift is helping small business owners navigate the economy by providing a flexible borrowing method that doesn’t require them to take out loans.
In this article, we explore exactly what a small business line of credit is, how it differs from a loan, and why it is becoming such a popular option for many entrepreneurs.
A business line of credit allows a business to borrow money as and when needed, helping cover short-term gaps in cash flow. Unlike a traditional loan, a line of credit tends to have a lower interest rate, and the amount borrowed can be higher. Similar to how a credit card works, a purchase can be made, and then once the amount has been repaid, the business can borrow again.
Financial institutions, such as banks provide the line of credit, and the aim is to provide businesses with access to funds (up to a predetermined amount) which can then be repaid in a more flexible manner. This option makes it an excellent tool for businesses looking for flexible business financing options to handle both planned and unexpected expenses.
Although both options allow businesses to borrow money from lenders, the key difference is how the money is received.
When a loan is taken out, the borrower has one-time access to the funds and is required to make interest payments at an agreed-upon rate until the debt is repaid. The borrower receives the entire amount up front, which tends to be for large expenses such as buying an asset or funding a large project.
On the other hand, a line of credit provides the borrower with repeated access to money. They will only pay interest on the amount borrowed at any given time.
Since the funds can be withdrawn and repaid at various stages, they don’t have to worry about paying interest on the total amount, spreading the borrowings out over time. This is a better solution when covering short-term cash flow issues or dealing with unexpected costs.
Many small business owners choose to opt for a line of credit due to the benefits it can bring to their finance management. Here are some of the key benefits:
Every lender reviews a line of credit application differently, but they typically consider similar factors to ensure the business will be a reliable customer.
Credit scores are likely to be the first port of call for both personal and business accounts. A strong credit score will work to the applicant's advantage, but generally, a score of around 680 and upwards will be considered acceptable. In some cases, a lender may accept lower credit scores but enforce a higher interest rate.
Another key factor for lenders is the length of time a business has been in operation. This helps them assess the risk of an applicant. The longer a business has been in operation, the more likely it is to accept their business.
Another consideration is business revenue. A lender will want to be sure that the business is generating enough money to pay back any borrowed funds. They will ask to see your financial statements, so it is best to come equipped with balance sheets, income statements, cash flow statements, and tax return documents.
Once an application has been accepted, the lender will make an offer that determines how much the business can access at any given time and whether there are any other associated fees.