Sometimes, cash flow can be pretty unpredictable on a month-to-month basis, with sudden spikes and drops.
For new businesses in their first few years, it can be hard to anticipate when those ebbs and flows will come, and making purchasing decisions too soon or too late can have problematic effects. That’s why so many companies rely on business credit lines to bring them a revolving flow of steady cash.
What is a business line of credit?
A merchant line of credit behaves much in the same way as a credit card: You tap into it when you need it, as often as you need it. Usually, you’re approved for a certain maximum amount. Then, you make monthly payments to pay off the money you borrowed with interest. They can be secured (requiring collateral) or unsecured (without requiring collateral). They differ from traditional business loans in the way their interest rates work, payment structure, and when the money can be used.
Why does a business owner need to be cautious?
Relying only on your line of credit alone can lead to problems. Like with credit cards, you can get stuck with something else besides just debt when you don’t pay back your small business line of credit: bad credit. Business line of credit interest rates are variable, meaning that when a small business owner doesn’t pay attention, the debt can get out of hand fairly quickly. Sometimes, you’ll suddenly have to deal with a spike in interest rates, for instance.
Then why do owners use lines of credit for business?
There are still many reasons to have an LOC in your back pocket. Unlike traditional small business loans, which can take months and months to be approved (when you’re not using an alternative finance lender like BFS Capital), once you’re approved for a credit line, you can use it whenever you need it, paying larger-than-predicted energy bills, buying inventory, investing in low-cost marketing efforts, or paying for anything else you’d need. It offers the flexible, fast funding solution business owners need to quickly adapt to a sudden situation. Unpredictable costs do come up in any business; that’s why it’s so appealing to get a business line of credit. For bad-credit businesses, though, getting a line of credit might be a lot harder.
How can I use my business LOC responsibly?
There’s no right or wrong way to use your LOC; there are just basic rules of thumb. It’s always a good idea to try and save up, ignore that you have any credit lines, and use your line of credit only when it’s needed and when you know you can pay it off within the next month or the next few months.
What happens when my business has bad credit?
Your bad personal credit may have a negative impact, but bad business credit is the thing to actually be worried about. You should continue to pay back whatever you take out or else your business will end up with bad credit. Business line of credit options may have lower maximums and higher interest rates when those scores are poor. The variable rates may get ridiculous at that point, and depending on your situation, you may want to look at another type of funding instead. A business loan with a fixed rate, merchant cash advances, or another type of funding option may be both easier to qualify for and easier to pay back.