Operating a business requires top-notch cash flow management. This means it’s essential to have sufficient cash on hand.
However, even if you had allotted enough money for your business’s daily needs and you’re keeping a close eye on money coming in and going out, it’s inevitable for certain circumstances to disrupt cash flow management at some point.
For instance, you might come across emergency expenditures, such as repairing a broken piece of equipment that is crucial to your operations. Or when you’re faced with overdue invoice payments that choke your business’s cash flow. These are just two among many scenarios that could affect cash availability.
Thankfully, you have one often overlooked solution at your disposal — an invoice-backed business line of credit (LOC). This credit opportunity is a flexible way to access money from your customers’ outstanding invoices — before they’ve been paid. You’re free to access the line of credit whenever you wish, and it can be used to fund any business purpose. If you want to know more, this infographic will get into the nitty-gritty of business LOC.
What is a Business Line of Credit?
Sometimes, you run out of cash on hand to cover operational expenses related to inventory, equipment repair, marketing, and payroll, among others. If your business is seasonal or picks up around the holidays, you might need a hand during the slow seasons. On the other hand, even as your business peaks, having access to cash is necessary to cover expenditures and take on opportunities. This is where a business line of credit (LOC) comes in handy.
A business LOC is a pre-approved amount that you can borrow from a loan provider. You can access the LOC whenever you need it and use the loan for whatever purpose you deem necessary for business financing.
How Does an LOC Work?
Unlike a traditional business loan, the loan amount in an LOC is not given as a lump sum. Instead, an LOC provides you with a pre-approved credit limit that you can draw from, as needed, to cover short-term expenditures. Repayments are made for the amounts drawn down, and interest is only charged on the amount used — not the entire credit limit. With an invoice-backed LOC, the amount is repaid as your customers pay their invoices.
Many lenders offer a business LOC. You can choose from a traditional lender like a bank or a new age, online lender. Expect the former to be more rigid when it comes to the application process. Banks require supporting documents, such as your company’s financial statements. If approved, you’re likely to receive a larger credit limit with a lower interest rate. Alternatively, you can apply from online lenders. They are more lenient, but some downsides include a smaller credit limit and a higher interest rate.
2 Types of Business LOCs
There are two types of business LOCs. They differ in terms of the application process and the loan agreement.
- Secured LOCs require that you agree to offer assets as collateral for the loaned amount. The assets may include real estate, equipment, accounts receivable, and other business properties of value. Should you default on payments, the provider has the assurance of recouping the money they released through the security asset. As such, secured LOCs are typically larger and have lower interest rates.
- Unsecured LOCs won’t ask you to pledge any of your assets. The downside is you will likely go through a more stringent application process. In fact, this option is primarily open for established businesses with great credit histories. If your application is approved, expect a smaller LOC attached to a higher interest rate.
5 Business Benefits of an LOC
Regardless of the type or source, a business LOC offers you an array of benefits.
- Stabilises cash flow – If the holidays are when you make the most significant chunk of your yearly sales, a line of credit can provide the cash flow necessary to take on new opportunities and hire extra staff. During your slow season, an LOC can help with operational expenses when you’re strapped for cash. A business LOC allows you to bridge your cash flow gaps throughout the year.
- Gives access to more operating capital – Having an accessible financing option that augments your working capital allows you to seize investment and expansion opportunities as they become available.
- Greater control on finances – Regular loans typically come with specific stipulations on how you can use the loaned amount. With a business LOC, you’re free to utilise the loan any way you wish.
- More flexible compared to term loans – You are free to utilise whatever portion of your credit limit you need. So you have the choice to either use only a fraction of your LOC or draw down the entire amount, depending on your business’s finance needs. And, you only pay interest on the drawn amount.
- Builds business credit score – If you regularly keep on top of your repayments, your business’s credit score may improve. That puts your business at an advantage. Should you need to apply for a regular term loan in the future, it’ll be easier to convince loan providers to approve your application and give you a lower interest rate.
5 Things to Consider Before Applying for an LOC
Having discussed the types of business LOCs and the financial institutions that offer them, the next order of business is ensuring that you end up filing an application that is most favourable on your end. Here are necessary considerations.
- Find a lender with a smooth application process – Applying for any type of loan is complicated. You’ll most likely face tons of administrative work before you get approved. Shop around for an LOC provider who can simplify the application process with integration capabilities for accounting software like Xero and MYOB and who will still help even if you don’t have access to the software.
- Need for collateral – This could become a problem, especially if you do not own real estate. Moreover, the tension with putting up your real estate as collateral often feels too close to home (and sometimes, it might literally be your home offered as security!). A lender whose collateral options include outstanding invoices significantly lowers that barrier. Additionally, you’ll rest safe knowing that you won’t risk your house if you were to default on your loans.
- Trading and credit history – While having an immaculate credit history will certainly help you in the application process, having a short trading history and a less-than-perfect credit score doesn’t need to hinder you when applying for an LOC. Look for a loan provider who can accommodate your business even if your situation looks like the latter.
- Paperwork – As with anything that involves finance, you may be faced with mountains of paperwork and a long list of administrative to-dos. Look for an LOC provider that offers straightforward and hassle-free approval with an intuitive platform to avoid unnecessary steps.
- Flexible credit limit – Having a business LOC that increases with your sales is certainly convenient for your expansion, as you won’t need to reapply to get access to the cash flow necessary for business growth. This is one of the good-to-haves when looking for a LOC provider.
Over to You
As a business person, you need the mental acuity to respond to pressing situations level-headedly. For example, if you run out of cash on hand to fund your daily operations, you must be quick to troubleshoot the problem. Grab hold of the potentials of a business line of credit. An invoice-backed line of credit is available for you to use to your advantage.
The last thing you want to do is give up when cash flow gets tight. Or to wait and see how things turn out. Be proactive. After all, the business you built from scratch is on the line. You have worked hard on your vision, and you can keep that dream you made into a reality charging on.
If you need a business ally, Earlypay provides competitive financing options. Contact us for more information.