How Can a Line of Credit Card Help Your Small Business

As businesses reopen and push forward, many are struggling with cash flow. The pandemic forced many to cut back on the essentials—or shut down entirely—leaving small-business owners with little to no extra funds to invest in growth. After a year of challenges, they’re now faced with the tough task of rebuilding with limited financial resources.

This is why small-business owners are looking for the best ways to quickly obtain affordable and flexible funding to bridge their cash gap and help them execute their reopening plans and strategies.

A business line of credit works to do just that: they provide flexible, affordable, and quickly accessible short-term working capital that new ventures can tap into when they need cash to pay for general business expenses and have sudden capital needs.

In this article, we provide a quick overview of what business lines of credit are, how small businesses can take advantage of them, and how they can help owners drive growth and smooth cash flows.

What is a business line of credit?

A business line of credit is a flexible financing option between a traditional business loan and a business credit. Like a loan, it provides funding that small business owners can use as needed. However, instead of receiving a lump sum deposit into your business checking account, you get access to a set of funds you can draw from whenever necessary—like how a home equity line of credit (HELOC) works.

Your ability to secure and maintain a business line of credit depends on factors such as creditworthiness, revenue, and financial history. Additionally, you only pay interest on the outstanding balance, not the total credit limit, making it a cost-effective and flexible way to manage cash flow.

When you apply, for line of credit application the lender sets a credit limit—typically ranging from $25,000 to $250,000—just like a credit card. Your credit report is crucial in determining your approval and borrowing limit. You only pay interest on the outstanding balance, and depending on the lender's risk assessment, you might encounter additional fees, such as origination, maintenance, or availability fees. Some banks also require businesses to pay off the entire balance periodically, a practice known as "resting the line."

There are two main types of business lines of credit. A secured line requires collateral—either business or personal assets—to back the loan in case of default. For example, some business owners use real estate assets, like how a home improvement loan might be secured against property. On the other hand, an unsecured line doesn't require collateral but carries more risk, as failing to repay could result in legal action against you or your business. Choosing the right type depends on your financial situation and risk tolerance.

Business lines of credit come with different types of business financing:

Quick Delivery of Much Needed Funding

You get access to working capital that you can use to pay business expenses and drive growth, similar to how a home improvement loan provides funds to renovate or upgrade a property.

Flexible Funding

Depending on your needs, you can draw as much or as little cash as you want up to the limit of your line of credit. This makes it especially useful for unexpected expenses. Other flexible credit instruments often don’t allow you to secure cold, hard cash, but lines of credit do—especially during the draw period, when you can access the funds as needed.

Lower Interest Rates

Flexible credit tools, like credit cards, typically have very high interest rates. Lines of credit can have higher interest rates but usually are lower than credit cards. This is especially true for businesses with a strong history of annual revenues and a high business credit score. Additionally, while credit cards often come with monthly payments and an annual fee, lines of credit may offer more favorable terms, depending on the lender.

Pros and cons of business lines of credit

Pros of Lines of Credit

Below are some advantages of line of credit:

1. They provide a flexible source of cash that can be used whenever necessary

Business opportunities often come without warning, and they're usually time sensitive. Whether you need to secure a new business location, land an important client, invest in critical new technology, or handle a surge in orders, the ability to move quickly is essential.

If you don’t have the cash to act fast, you risk missing out. Traditional loans aren't ideal in these situations—they take too long to secure, often requiring extensive disclosures and credit approval, and you can't easily adjust the borrowed amount once it's set. The repayment terms may also be too rigid for situations where flexibility is key.

A line of credit provides a flexible working capital pool that can be used to navigate these unexpected opportunities. With a limit set by the lender based on your credit score, you can borrow cash whenever needed, if you haven't hit your limit.

This is how a line of credit works: you only pay interest on the amount you borrow, not the full credit limit. Plus, this makes it a much more adaptable option when funds are needed quickly and efficiently without requiring a lump sum deposit into your business checking account. It's also important to consider what credit offers are available, as they can vary in terms of interest rates and repayment flexibility.

2. Lines of credit are an excellent (and inexpensive) way to build credit

When businesses are just starting out, securing loans and other financing options often require the owners of small business to make personal guarantees, use personal credit scores, or give up huge collateral due to a lack of credit history. Building up credit requires you too successfully manage credit.

One of the easier forms of credit to obtain to start building history is business credit, but their extremely high interest rates can cause them to become extremely expensive if mismanaged or if they need to be used for sudden expenses.

Lines of credit are a happy medium between the typically stricter requirements of a traditional loan and the risk of a business credit card. Small businesses can start with very small lines of credit and establish a positive history by using the cash available and making payments on time.

3. Allow businesses to “smooth” cash flow during down seasons

One of the biggest advantages of a business line of credit is its ability to help small business owners—especially those in seasonal industries—maintain steady cash flow throughout the fiscal year.

Restaurants, clothing retailers, resorts, landscapers, food truck owners, tutors, outdoor tour guide services, personal trainers, and many other businesses operate on seasonal revenue cycles.

They generate most of their income during peak season and experience a significant drop during the off-season. For example, personal trainers often see an influx of clients between January and the summer months, followed by a slowdown in the fall and winter. Managing cash flow during these fluctuations can be challenging, especially when aligning expenses with the business’s billing cycle. A credit account can help bridge financial gaps and ensure yearly stability.

This fluctuation can create cash flow challenges for businesses with year-round expenses like rent and payroll. Managing surplus revenue from the peak season throughout the year can be difficult, especially in changing business environments. Since you can’t simply pause payments when revenue slows, a secured line of credit can provide a reliable financial cushion.

Lines of credit offer a way to balance peak and off-seasons, ensuring a more stable financial position year-round. Instead of earning 80% of your revenue in the first quarter and struggling to stretch it over the remainder of the year, you can use a line of credit to smooth cash flow. This allows you to cover payroll, engage in pre-season marketing, pay rent, and handle other operational expenses.

Many of the best line of credit lenders offer competitive rates, but businesses with lower credit scores may face higher interest rates. Additionally, lenders assess credit approval based on financial history, revenue, and collateral, determining the amount and terms available to your business.

Cons of Lines of Credit

Below are some of the disadvantages of line of credit:

1. Debt is debt, no matter how advantageous

Lines of credit are still a form of debt, no matter how you spin it. The money you borrow must be paid back, with interest, promptly, adding another liability to your small business's financial statements. This extra debt can impact future financing costs, as it may raise your "current ratio" and other financial metrics, potentially affecting loan applications. Whether you choose a secured line of credit or an unsecured option, evaluating the economic impact on your business is important.

As with any loan or source of financing, carefully consider your business's credit needs to determine if a line of credit  is essential. Exploring alternatives, such as working with a credit union for more favorable terms or opening a different type of credit account, may be beneficial. Other fast financing options, like invoice factoring or merchant cash advances, can provide quick cash when needed.

2. Business lines of credit aren’t typically large enough for big purchases

If you’re looking to launch a major product or need a very large cash infusion—primarily as you work to recover from COVID-19’s impact on your business—a line of credit may not be enough. Financial institutions are hesitant to provide extensive, flexible financing options because they are inherently riskier and tie up capital that could be used for other loan options. Additionally, securing higher credit limits often requires good credit, making it more challenging for some businesses to access the necessary funds.

Lines of credit typically have lower total borrowing limits than investor capital or traditional loans and increasing those limits can be challenging. Banks assess eligibility based on revenue, credit history, and collateral, making securing a significantly higher limit difficult. Additionally, most lines of credit come with a draw period, during which you can access funds before repayment terms begin, like a home equity line of credit (HELOC).

Exploring options like equity financing, SBA loans, or term loans may be more suitable for substantial funding needs, as they offer higher borrowing amounts and structured repayment terms.

3. There is very high (but low probability) downside risk when lines of credit are mismanaged

As we discussed, lines of credit require either a personal guarantee or the pledge of collateral in the form of business or personal assets. Your credit history plays a significant role in determining your eligibility for these lines of credit. A strong history can lead to lower interest rates, making borrowing more affordable in the long run.

However, suppose you default on the credit line due to business failure or other circumstances, then the bank has the right to seize the collateral or take legal action against the borrower or the borrower's business to recover their losses.

This can result in severe consequences, including business closure, personal and/or business bankruptcy, or other outcomes. It's important to fully understand the risks before you apply for line of credit online, especially if the collateral involves significant personal or business assets.

FAQs about Line of Credit

What does a line of credit do for a business?

An unsecured line of credit gives businesses access to funds that can be used for any expenses that arise, much like a small business loan. However, unlike a traditional loan, there’s no lump-sum disbursement at account opening, which means you don’t have to worry about a fixed monthly payment. This flexibility makes it one of the best line of credit loans for businesses needing quick, adaptable financing without the constraints of a large, upfront loan amount.

What are the benefits of a line of credit?

A line of credit provides continuous access to funds that you can withdraw and repay as needed, offering flexibility for unexpected expenses. Interest is only charged on the amount you use, making it a cost-effective solution. This type of financing is especially useful for situations where cash needs can arise suddenly.

How can a line of credit affect cash flow in a small business?

If your business faces cash flow gaps, it could affect your ability to meet payroll on time. To ensure employees are paid without disruption, a line of creditcan provide the necessary liquidity to bridge the gap while you wait for accounts receivable to be collected. This flexible financing option with competitive rates helps stabilize cash flow and keep operations running smoothly.

What is the purpose of a credit line?

A credit line is a versatile financing option that lets you borrow as needed, up to a predetermined limit, providing flexibility and control over your funds.

How much of a line of credit can I get for my business?

A business line of credit typically ranges from $5,000 to $500,000, with the approved amount depending on the company's financial history and creditworthiness.

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