Running a business is expensive. Beyond the large costs you need to cover every month or every few weeks—your office space and employee payroll, for example—there are always small things that need to be taken care of daily. Therefore, as a business owner, you know how important your cash flow is to keep things running smoothly.
But cash flow challenges are pretty much inevitable; all businesses have ups and downs, and even if your revenue remains high, there might come a point when you have little access to cash. So, what do you do?
When you need a short-term funding solution, having a revolving line of credit on the back burner can help immensely. Let’s take a deeper look at why every business owner needs access to a revolving line of credit.
What is a revolving line of credit?
A revolving line of credit is simply a pool of funds that you have approved access to. After qualifying for a credit line through a bank or other institution, you can borrow from this amount whenever the need arises. When you repay the funds you’ve borrowed from your line of credit, you’ll pay interest on only the amount that you borrowed, and once you repay those funds, your credit available goes back to the original amount.
Unlike other business funding, a revolving line of credit doesn’t come with a set repayment plan, because the amount you end up borrowing is up to you. Plus, you can continue borrowing and repaying funds over and over as your needs demand.
Here are some of the biggest benefits of having a revolving line of credit:
- Flexible repayment terms: Unlike a term loan, there is no set amount you need to pay each month if you’ve borrowed from your revolving line of credit. If you have a slow month, you have the option to simply pay the minimum amount due. (Of course, keep in mind that the amount you borrow will continue accruing interest until you’ve repaid all of it.)
- Flexible usage: With other types of business funding, the money you borrow can be used for only one specific, preapproved purpose; however, with a revolving line of credit, you can use the cash for whatever business expense you need covered.
- Build business credit: Building credit is crucial for any new business owner because many lenders won’t approve you for a business loan unless you have a proven history of creditworthiness and a few years of experience. This may seem like a catch-22: You must make some money before you can borrow it. Borrowing and responsibly repaying money from your revolving line of credit is a great way to build your business credit history and will help you gain approval from other lenders in the future.
- Quick access to cash: Sometimes things happen that we just can’t prepare for. For example, maybe you received a big order from a new client, but you don’t have the inventory on hand to fill it, or enough liquid cash to purchase new inventory. A revolving line of credit is an excellent backup plan to cover the inventory you need so you can fill the order on time and secure a potential long-term client.
The difference between a revolving credit and credit cards
There are a few differences between a revolving line of credit and a business credit card. First, you don’t need an actual card to access your line of credit. Second, you don’t need to make a specific purchase to get access to the funds, the money can be transferred into a bank account for any reason, before an actual transaction has been made. One way to think about it is that a business credit card is a type of revolving credit it. But there are other options.
What to know about applying for a revolving line of credit
Of course, not every line of credit functions the same way. There are many different types of revolving lines of credit, from short-term and long-term lines of credit to business credit cards.
In the past, banks would have been one of your only options for applying for a revolving line of credit. But thanks to the internet, there are plenty of alternative lending sources available for business owners of all different credit backgrounds, and at different stages in the business cycle.
Banks will, for the most part, still be your most financially-sound source of funding when it comes to applying for a revolving line of credit. However, just as many business owners won’t be approved for term loans through a bank, many also won’t be approved for revolving lines of credit through a bank.
If you have a poor credit history and little business experience, it’s harder to secure a business loan with a desirable low-interest rate and long loan term. The same basic rule applies to a revolving line of credit: Business owners who don’t meet the revenue, credit score, or business history requirements of long-term business loans are likely to only be approved for a revolving line of credit with lower funds available and higher interest rates and APRs.
On the other hand, if you have several years in business, a good credit score, and strong revenue, you are more likely to be approved for a “better” revolving line of credit. If you’re more likely to qualify for a medium- or long-term business loan, you’re also more likely to be approved for a revolving line of credit with more available funds and a lower interest rate.
It’s also important to note that some revolving lines of credit will require you to put up some sort of collateral or guarantee against the amount you borrow. While there are revolving lines of credit that are unsecured by collateral, these tend to have stricter qualification standards (much like traditional bank loans).
Should you apply for a revolving line of credit?
In the simplest terms, a revolving line of credit is an excellent backup plan, especially if your business has inconsistent cash flow. It is also typically easier to qualify for a revolving line of credit than other business funding.
However, remember that the interest rates on what you borrow from a revolving line of credit are often higher than other business loan options. It also may require collateral, which may not be an option for some business owners. But if you know you will be responsible in repaying what you borrow, a revolving line of credit is a great way to set your business up for a successful future.
SOURCE: ALL BUSINESS