Understanding business line of credit
Business loans vs.
Line of credit
The main advantage of a line of credit is its flexibility. It is an arrangement with a financial institution that gives a business access to a maximum amount of credit–sort of like a credit card. Businesses can tailor what they withdraw (known as ‘drawing down’) according to their needs.
Interest tends to be paid only on the amount a business spends, not on the entire credit line they were approved for. Each drawdown becomes a separate business loan.
A business loan, on the other hand, is a single sum of credit given by a lender to a business. Categorised as a debt-based financing arrangement, it is often used by companies to fund investment and growth, or cover unforeseen business costs. Because a business loan is a fixed amount, it suits companies that know exactly how much finance they need.
How can you benefit
from a business line of credit?
Small businesses are often the most vulnerable when it comes to the effects of payment gaps and unforeseen expenses. A delayed invoice can mean serious cash flow problems: a lack of working capital to operate the business, inability to replenish inventory, and even problems with payroll.
Additionally, businesses experiencing high surges in growth will often need flexible access to finance to maximise profitability. A line of credit conveniently resolves this problem.
It provides a safety net for borrowers who know they might need additional finance, but are unsure about how much and when. Alternatively, it can support current financial challenges, such as managing cash flow issues, bridging receivables and maintaining vital assets.
Revolving and non-revolving credit lines: what’s the difference?
The only fundamental difference between these two lending options is what happens after you have repaid the credit line. If you make regular payments on a revolving account, the lender may agree to raise the credit limit–again, in a similar way to a credit card.
There is no set monthly payment amounts with revolving accounts–interest accrues on what’s been borrowed. When payments are made, the repaid funds become available for borrowing again.
With a non-revolving arrangement, the credit line does not replenish. Once you repay the withdrawn amount, the account is closed. This doesn’t mean the credit line won’t be available again–a lender may offer a similar or increased amount after reviewing the borrower’s circumstances.