The Small Business Administration defines a line of credit as a loan given by a financial institution to finance short-term current capital needs, such as inventory purchases or operating expenses.
Below, Salmon outlines the pros and cons of a business line of credit.
The main benefit of a line of credit is that it acts as a safety net for your business, Salmon says. "It acts like working capital and makes funds available for your business while you wait for payments on accounts receivable," he explains. "You can rest easy knowing your employees will get paid even with unpredictable, temporary cash flow slowdowns or problems."
A line of credit is also a means of leverage to help kick-start business growth. "Having the funds for extra inventory for a seasonal push can be tough for a small business," Salmon says. "The line of credit could permit for that additional purchase of stock and allow you to be more opportunistic."
A less obvious benefit is that it can strengthen your relationship with your financial institution. Making payments on time and abiding by the arrangements associated with its use shows viability of your company and character of management. Should you decide to expand your business, a strong relationship with your financial institution will help you gain future acquisitions faster.
Salmon warns that a line of credit can be easy to misuse and "can get you into trouble."
"As a business owner, you want to monitor how much you access your credit line. Most are variably priced, meaning the rate can change quickly," he says.
Salmon also points out that just like a credit card, you should make the required payments, or your rate could increase sharply. In addition, owners should be aware of any added requirements that might be associated with having access to the line. For example, quarterly accounts receivable reporting and financial requirements regarding liquidity and reporting are common. "Owners should ask themselves if they are ready and willing to commit to such oversight," he says.
Having a line of credit means there is on-record indication of how responsible you are with managing or mismanaging your money. "It will count in the grand scheme of potential credit and be incorporated in any future decisions with your financial institution," Salmon explains.
If you're interested in obtaining a line of credit for your business, talk to your financial institution about your options. Each institution has its own criteria for obtaining a line of credit, such as two-years-in-business minimum or collateral. Salmon adds that sometimes, "a small business is able to secure a line of credit with the collateral being the assets of the business or personal assets if need be."
If your business doesn't qualify, Salmon says there are other loan alternatives. For example, Navy Federal recommends a business credit card as a viable option for its members that need funds from time to time for small purchases or cash advances.
Follow Salmon's advice above and talk to your financial institution to see if a business line of credit is right for you.