Just like with personal credit, there is a right way and a wrong way to use a line of credit for your business. Done wrong, using that line can add incremental stress to your cash flow and operations until you run out of room and ultimately close down. Done right, it can give you what you need to create an upward spiral of cash flow, expansion and success.
Of course, doing it right isn’t as simple as we just made it sound. Properly leveraging a business line of credit takes skill and knowledge about financial management. We spoke with a variety of successful entrepreneurs about the ways they use credit lines to identify the top ‘dos’ and ‘don’ts’ of leveraging a business line of credit.
Line of Credit vs. Installment Loan
Before we get to the actual ‘dos’ and ‘don’ts’, let’s look at the difference between the two most common kinds of small business loans.
- Installment loans are what most people think of when they think of a loan. An installment loan is a static amount you borrow once, then pay off in regular installments until you’ve paid it off entirely. Think of your auto loan or mortgage – they are examples of consumer installment loans.
- Lines of credit are more synonymous with credit cards in the way that you are given a credit limit and you can borrow against that in real time. You pay off your balance as you are able, with a minimum monthly payment based on the current balance.
The Dos and Don’ts of Leveraging a Business Line of Credit
Do “begin with the end in mind.” Because lines of credit operate more like credit cards than loans, it can be tempting to use your line of credit as a portable petty cash fund. Instead, draw funds only when you have a specific, organized and well-researched plan to make more money than you will spend in interest and fees.
Don’t fail to shop around for lines of credit. All business lines of credit are not created equal. As with all resources, getting more for less is the definition of leverage. In order to properly leverage your business line of credit, a bit of comparison shopping is necessary.
Do use the line of credit to bridge cash flow challenges. Most businesses in their growth stages have weeks where income is inconveniently later than the need for that income. This can strain relations with vendors, customers and staff, and add stress that could keep you from operating at your peak performance. A line of credit can smooth all of those waters, letting you pay for what you need when you need it.
Don’t pay too much attention to the minimum payment. Making merely the minimum payment each month could make your operating funds more expensive. Instead, try to pay more whenever you can. By the same token, if you know that you will not be able to make the minimum payment, communicate with your lender as soon as possible. Most lenders are flexible when you are experiencing a rough month as long as you communicate with them ahead of time.
Do make strategic plans. Remember that you have access to funds made available by a business line of credit. Those funds can make expansion, stocking inventory, payroll, and a host of other moves possible. The more you leverage the available funds from a line of credit, the faster your business can grow.
Don’t wait until you need the money to set up a business line of credit. Reputable lenders will charge either nothing or a nominal fee to keep a line of credit available on demand. It’s better to have funds at the ready and have the ability to access cash when you need it than to wait for a dire need before requesting a line of credit.
Do transition to cash flow for funding when you are ready. More than one business owner has fallen into a pattern of relying on credit funds over and over, but once your company has achieved a strong structure that leads to high performance, you should make the move to relying on your cash flow for expenses. If needed, you can always come back to a business line of credit to fund larger or new company initiatives.
Whether your business is brand-new, making its first leap into a bigger pond, or beginning its tenth market expansion, a business line of credit can be a powerful solution to many growth or scarcity related problems.