Introduction to Business Lines of credit

With a line of credit, you can make use of monies up to a maximum amount set by the bank. You pay interest only on the amount that you use. The interest rates on these loans are variable. In addition, lines of credit have renewable periods from 90 days to several years; but for extended periods, the lender will ask for annual reviews.

In short, with a line of credit:

• You can withdraw funds up to a limit set by your bank.
• The amount available for withdrawal increases or decreases depending on how much of the line you use.
• You can use the line regularly, for example, for buying inventory or working capital.
• You will make payments on the amount withdrawn from the line of credit plus interest.
• You can pay a portion of the amount that you used and repay it over time (there will be a minimum amount required) or pay the full amount used at any time.

A line of credit is good for businesses in need of making seasonal purchases (such as clothing) or those in manufacturing. The lender will focus on a borrower’s cash flow, earnings records, financial ratios, and credit score. Banks offer low-documentation loans that make the process faster.

In some cases, it is only a one-page application and the banks will have an answer in a couple of days. There are several types of credit lines to choose from:

Revolving Line of Credit: The lending institution commits a certain amount for the borrower to use for a determined period, usually from one year or more. The borrower can use all or a partial amount and pay interest only or interest and principal.

Demand Line of Credit: This type of loan is similar to the revolving line of credit with the exception that the bank can request to be paid at any time. There is no set repayment schedule for this loan.

Asset-Based Line of Credit: This is a revolving line of credit based on accounts receivable, inventory, or fixed assets. The amount available for loan disbursement is qualified by a formula, which is the outstanding accounts receivable, plus inventory, multiplied by a factor (the factor for inventory is 50%, and 80% for accounts receivable). The bank checks aging accounts receivable, borrower’s debtors, and inventory levels each month.

The bank might offer other payment terms for a line of credit:

• The bank might require that each withdrawal be paid back within a specific period, usually 90 days.
• The bank can require that the borrower keep a zero balance on the account, usually 90 days.
• Most banks ask that the borrower open a business bank account such as a checking or money market account as a consideration to offering the loan.