As a small business owner, you’re no stranger to the ups and downs of cash flow. There are times when you need immediate funds to seize opportunities or weather unexpected expenses. This is where a revolving line of credit can come to your rescue. Let’s go over the world of revolving lines of credit, explore their benefits and help you understand if they’re a good fit for your business.
What Is a Revolving Line of Credit?
A business line of credit is a flexible financial tool that allows your business to borrow a predetermined amount of money from a lending financial institution. What sets it apart from traditional loans is its revolving nature. Here’s how it works:
Credit limit. When you establish a revolving line of credit, you are assigned a maximum credit limit. This limit represents the total amount you can borrow.
Access to funds. You can withdraw funds from your line of credit whenever you need them, up to the credit limit. It’s like having a financial safety net at your disposal.
Repayment. Once you’ve used a portion of your credit line, you’re required to repay the borrowed amount, along with interest and any applicable fees. What makes it “revolving” is that as you repay, the funds become available for you to borrow again.
Interest. You only pay interest on the amount you’ve borrowed, not the entire credit limit. This can make it a cost-effective solution for managing cash flow.
What’s the Difference Between a Line of Credit and a Revolving Line of Credit?
While the terms “line of credit” and “revolving line of credit” are often used interchangeably, they do have some key differences:
Revolving credit. The primary distinction is the revolving nature of a revolving line of credit. With a non-revolving line of credit, once you borrow and repay the funds, they may not be available for borrowing again during the life of the agreement. In contrast, a revolving line of credit renews as you repay, offering ongoing access to funds.
Payment terms. Non-revolving lines of credit often have fixed payment terms and may require you to pay off the balance in a lump sum after a certain period. Revolving lines of credit, on the other hand, allow for more flexibility in terms of repayment.
Interest calculation. Interest on a non-revolving line of credit is typically calculated on the outstanding balance. In contrast, revolving lines of credit generally calculate interest only on the amount you’ve borrowed, which can be a cost-saving advantage.
Which Is Better: Revolving or Non-Revolving Line of Credit?
The choice between a revolving and non-revolving line of credit depends on your business’s specific needs and financial situation. Ultimately, it’s crucial to assess your business’s unique situation and consult with financial experts to determine the best fit. Here are some factors to consider:
Cash flow needs. If your business frequently faces cash flow gaps or needs to access funds on an ongoing basis, a revolving line of credit could be the better choice due to its renewability.
Fixed expenses. If you have a specific one-time expense, such as purchasing equipment, a non-revolving line of credit with fixed terms may be more appropriate.
Interest costs. Revolving lines of credit often come with lower interest rates than non-revolving ones, making them a more cost-effective option for businesses that need flexibility.
Creditworthiness. Your business’s creditworthiness will influence the type of line of credit you can secure. Revolving lines of credit may require a stronger credit history and financial stability.
How Do Revolving Lines of Credit Compare to Business Term Loans?
Business term loans are quite a bit different from business lines of credit. They offer a lump sum up front, typically for a specific purpose, with fixed repayment schedules to be paid over a period of time. Unlike lines of credit, term loans (otherwise referred to as “installment loans” or even just “small business loans”) lack the flexibility to adjust repayments according to short-term cash flow variations. Term loans may be a good option for businesses with clear, defined projects or capital expenditures.
How Do Revolving Lines of Credit Compare to Business Credit Cards?
Revolving lines of credit provide businesses with a predetermined borrowing limit, much like credit cards. However, lines of credit often offer higher credit limits compared to business credit cards, making them suitable for more significant expenses or ongoing operational needs. The flexibility of lines of credit lies in their ability to adapt to changing cash flow, allowing businesses to borrow and repay on their terms.
Business credit cards offer convenience and quick access to funds for smaller, immediate needs. However, they may have lower credit limits and higher interest rates compared to lines of credit. While credit cards are suitable for everyday purchases, lines of credit excel in addressing larger or more prolonged financial requirements.
How Do Revolving Lines of Credit Compare to Personal Lines of Credit?
Business lines of credit are specifically designed to meet the financial needs of a business. They often come with higher credit limits, tailored to accommodate the larger-scale financial requirements of business operations. The usage of funds from a business line of credit is expected to align with the needs and goals of the company, whether it’s for managing working capital, covering operational expenses, or seizing growth opportunities.
Personal lines of credit are intended for individual financial needs. While they offer flexibility similar to business lines of credit, the credit limits are typically lower. Personal lines of credit are suitable for personal finance, emergencies or projects that may not be directly related to the business. However, the distinction between personal and business finances is crucial, and using a personal line of credit for business purposes may lead to complications in tracking expenses and tax implications.
What Are the Benefits of a Revolving Line of Credit?
Now that we’ve established what a revolving line of credit is and how it differs from other forms of credit, let’s dive into its benefits for small businesses:
Flexibility. One of the most significant advantages of a revolving line of credit is its flexibility. You can access funds as needed, making it an ideal solution for managing irregular cash flow or seizing opportunities that require quick capital injections.
Cost-effective borrowing. Since you’re only paying interest on the amount you’ve borrowed, a revolving line of credit can be more cost-effective than non-revolving credit, where you often pay interest on the entire credit limit.
Ongoing access to funds. The revolving nature of this credit line means you can continually access funds as you repay, providing a reliable source of working capital. This is particularly valuable for businesses with seasonal fluctuations.
Emergency preparedness. A revolving line of credit can serve as an emergency fund for unexpected expenses, helping your business stay afloat during challenging times.
Building credit history. Responsible use of a revolving line of credit can positively impact your business’s credit history, making it easier to secure larger loans or lines of credit in the future.
Financing growth. When your business is ready to expand, a revolving line of credit can provide the necessary capital to fund growth initiatives, such as opening a new location, launching a new product line, or hiring additional staff.
Where Can You Get a Business Line of Credit?
Securing a revolving line of credit for your small business involves several steps:
Evaluate your needs. Start by assessing your business’s financial needs and cash flow patterns. Determine how much credit you require and how often you anticipate needing access to funds.
Prepare financial documents. Financial institutions will want to see your business’s financial history, including income statements, balance sheets, and cash flow projections. Make sure your financial documentation is in order.
Check your credit. Your personal and business credit scores play a significant role in your ability to secure a revolving line of credit. Review and improve your credit scores if necessary.
Research lenders. Explore your options when it comes to lenders. Banks, credit unions, and online lenders all offer revolving lines of credit. Compare terms, interest rates, and fees to find the best fit for your business.
Apply. Once you’ve selected a lender, submit your application along with the required documentation. Be prepared for a thorough review process.
Use responsibly. If approved, use your revolving line of credit responsibly. Make timely payments and avoid borrowing more than you can comfortably repay.
DISCLAIMER: This content is for educational and informational purposes only, and is not intended as financial, investment, or legal advice.