Small businesses that are cash-strapped and finding it hard to secure funds from investors can opt for a line of credit (LOC). Under this arrangement, the borrower has to repay the creditor, the bank or financial institution through monthly payments.
Business owners, start-up founders or investors find LOC a very convenient financial solution. LOC can be used to fill gaps in cash flow or cover other operating expenses. But LOC is not easy to secure – only businesses with good credit history, good cash flow, and collateral can have access to this quick cash flow.
One of the common mistakes small business owners do is overusing their lines of credit. They fail to realize that lines of credit are utilized only for short-term working capital needs. And such mistakes can make it hard for them to get additional credit or even lead their business out of operation.
Here are some useful tips that you can apply and manage the lines of credit wisely without stressing the capital needs of your small business.
Remember, it’s only a Short-term Option
A line of credit can be useful for taking care of the immediate obligations that need to be addressed in a business. It can also help with cash flow in crucial stages of a business where growth is rapid. However, unplanned borrowing will result in outstanding lines of credit.
Borrowing excessively on your line of credit would not only hurt the financial health of your business and your credit score but also prevent lenders from increasing your line of credit or approving future loans. It would be wiser to plan, foresee and avoid taking too much debt.
Compare Terms and Interest Rates with multiple lenders
High interest rates can also result in outstanding lines of credit. Do not settle with one lender. Approach multiple lenders and decide who can provide you the best deal. Some of the questions you can ask are:
- Are the interest rates fixed or variable?
- Are there any hidden fees or costs attached?
- Payment schedules.
- The limit of LOC
Regularly Monitor your Line of Credit Account
Sudden loss of line of credit can devastate a small business. Banks can pull back or cancel credit lines. Almost 38% of businesses have reported that their lines of credit were decreased. Banks can also turn down your request for the extension of your credit limit or even ask you to increase collateral, agree to severe terms or interest rates.
Regular monitoring of your interest rate changes and identifying restrictions on credit limits is critical. Make timely payments, keep your accounts up-to-date and avoid penalties.
Avoid borrowing more than you can repay
Don’t take a loan just because it is available, as borrowing money also costs money. You will not be just repaying the principle, in addition, you will be paying huge interests and the fluctuating interest rates will definitely harm your small business.
The number of credit-based applications you make, the late payments or any default on loans will impact your credit score. And with a bad credit score, it will be difficult to get a loan approved in the future.
Lines of credit, though they do have some perks, are truly a case of “too good to be true.” There are the pros and cons, as there are with any decision, and it’s important to truly weigh the benefit of extending a line of credit against perhaps alternative and cheaper options.