Access to funds is essential if you run one of the estimated 33.2 million small businesses in the United States. Managing operating costs can be challenging, but having access to available funds enables you to seize growth opportunities. For those with short-term cash flow challenges, business lines of credit may seem like a viable solution to handle different needs. However, business lines of credit come with advantages and drawbacks. Considering the advantages and disadvantages of business lines of credit can help you determine if it is right for your needs.
Business Lines of Credit Pros
Faster to Obtain Than Loans
With an open line of credit, your business can access available funds faster at a moment’s notice. This is much faster than applying for a loan every time you need it. Consequently, it is easier to capitalize on opportunities or handle the unexpected.
While business loans involve lump sum payments and interest payments based on the amount owed, business lines of credit work more like credit cards. Interest is calculated only according to the current principal amount, and not the value of the entire credit line. As a result, it can reduce the size of interest payments if companies only tap into the portion of the portion available in their credit limit.
Improved Cash Flow
Many small businesses struggle with intermittent cash flow problems . For example, seasonal businesses may have major booms during peak times of the year and financial struggles during the off-season. Other small businesses may see income gaps on occasion or experience difficulties if a large invoice from the customer is not paid on time.
With a business line of credit, small businesses can use the money to cover lean time. Consequently, they can handle expenses on time even if income is temporarily a challenge.
Since lines of credit work like credit cards, they offer a chance to build a long-standing relationship with a lender. The account can remain open as long as the company can take advantage of it based on the terms in the agreement. Consequently, a business may be able to show a lender that it acts responsibly over time, and which may gain access to other lending products or reduce future credit line growth.
Higher Interest Rates
Typically, business lines of credit come with high interest rates. While some may be on the low end, approaching 8%, in others the APR may approach 60%, if not higher. Consequently, they can be expensive in the long term, especially if your company habitually balances.
In many cases, business lines of credit have higher fees than alternatives such as business loans. Origin processing and maintenance fees can all be part of the equation. And they can add up faster creating a business line of credit more expensive than some people expect.
As with many business-focused lending products, the process of obtaining a business line of credit is rigorous. This includes checking the company’s credentials and the person applying. Consequently, the document requirements are much wider than most consumer loans and the creditworthiness of both parties is assessed.
Usually, the limit of the business line of credit is lower than the limit seen by companies for business loans. Consequently business lines of credit may not offer enough to handle high-cost financial challenges, leaving a company with a resource that does not meet its actual needs.