Your available cash balance is an important consideration in your company. Without sufficient cash flow, you cannot fund the daily operations of your business. A line of credit can help solve a cash flow issue. If the line of credit is mishandled, however, it can damage your credit rating – or even put you out of business. Follow these tips to make smart decisions about a line of credit.
Cash shortage examples.
Two assets that use up a great deal of available cash are accounts receivable and inventory. If these assets are not converted into cash fast enough, they can generate a cash shortage.
Say, for example, that you manage a commercial plumbing company. Your clients are hotels, office buildings and factories. The business requires about $10,000 a week in cash flow. The firm has $30,000 in receivables that you expect to collect in the next three weeks. You need available credit to fund your cash needs for the next several weeks. A line of credit might be a solution.
Assume that your plumbing company gets a large contract at a large hotel. The project is much larger than you normally handle. Your existing cash flow won’t allow you to pay for materials (a component of inventory) and labor costs for the new job. The large hotel will pay you each week over a two-month period. A line of credit could help you take on the new project.
Line of credit basics.
A line of credit (LOC) is a loan. The LOC provides available cash that can be accessed as needed by the business. Your LOC is designed to address a short-term cash flow problem. Many businesses borrow from a line of credit and repay it in a matter of weeks. The balances can change frequently. Like other loans, the line of credit balance is assessed interest.
As this article points out, a line of credit may be either secured or unsecured. A secured LOC requires that the borrower put up collateral. Collateral is an asset that secures repayment of the loan. If the borrower doesn’t pay, the lender takes ownership of the asset. New businesses- or companies that weaker financially- may have to provide collateral for a line of credit.
Unsecured LOCs are simply backed by the borrower’s ability to pay. A firm with a track record of generating sales and earnings may be able obtain an unsecured line of credit.
Benefits of a line of credit.
Using a line of credit can have several benefits, as stated in here. A business can raise capital by borrowing or selling equity (ownership). The LOC allows a business to get access to cash without selling ownership. The business owner can retain control of the company.
The LOC helps the owners avoid contributing more personal cash into the business to fund operations. A line of credit also offers flexibility. A business can borrow just the amount they need, and repay that amount quickly. Fast repayment means that less interest is incurred on the loan balance.
A line of credit allows the business to establish a strong credit history. For instance, assume that a manufacturer uses the LOC every two weeks to fund payroll, then pays off the balance within a week. Using the line of credit responsibility shows other potential lenders that the manufacturer is a good credit risk.
Line of credit: The risks.
Using a line of credit also presents some risks. Most importantly, the LOC is a loan that must be repaid. If principal or interest on the loan is paid late, that will hurt the firm’s credit rating. If a secured loan is not repaid, the lender will have a claim over the borrower’s collateral.
It’s important for the borrower to carefully forecast cash flow needs. That analysis should include the amount of borrowing from the LOC, and how quickly that balance will be repaid. If the borrower is a sole proprietor, business owner may be personally liable for repaying the loan. That puts the owner’s personal and business assets at risk.
As with any loan, the borrower will include loan fees and interest costs. If a business allows the balance to grow, so will interest costs. The interest expense needs to be in the company budget, along with the other costs to operate the business.
A business with a low credit rating may have trouble getting a large enough line of credit. These types of firms will also be assessed a higher interest rate on any loan balance.
Monitoring your credit rating.
To grow your business over time, you need to maintain a strong credit rating. Sometimes, incorrect data is reported to credit bureaus. You may need to contact a credit repair company to help you remove the inaccurate information. A business owner can search the web for creditrepair.com reviews and gauge their performance by reading testimonials from real customers and clients. Consider using one of the more reputable firms to address credit-reporting issues.
