Almost all business owners will face a time when bills or employees need to be paid, and there isn’t enough cash on hand to pay it all. Working capital (what’s left over when current obligations are subtracted from current assets) is necessary to keep businesses afloat and to allow growth to happen. Unfortunately, businesses don’t always have enough of cash, and sometimes tough decisions have to be made.
That’s where a line of credit can be useful. Having access to a line of credit allows businesses to operate with enough money on hand to pay for short term debt and expenses, which is essential in times of growth or transition.
A line of credit is especially useful in industries with major seasonal fluctuations. A line of credit can fill in the gaps in lag times between when bills are due and when sales are made or payment comes in. For businesses that rely on carrying physical goods, lines of credit are generally used to pay for inventory. For services-based businesses, a line of credit is often used to make payroll when outstanding accounts receivable are high.
So how should a responsible business owner manage a line of credit?
A line of credit should generally only be used for short-term purposes (defined by most banks as less than a year). For acquiring long-term assets— such as large pieces of equipment— financing with a lease or term loan is preferable. An easy rule of thumb: short-term debt is used for short-term assets, and long-term debt is used for long-term assets.
Lines of credit are generally made for one year at a time. If you plan to keep a line of credit for more than a year, discuss this with your banker at least a quarter before it’s time to renew. If your business is experiencing a working capital shortfall during the current line of credit period, it’s especially important to start discussing renewal fairly early.
It’s generally a good idea to let your line of credit “rest” a few times during the year. This means that the balance should be brought to zero. If you can do this, it will demonstrate to the bank that you can manage your line responsibly. Establishing an automatic monthly sweep from your bank account to lower your loan amount outstanding is an excellent way to manage your line of credit and save you some interest cost. This is proof of your company’s cash flow capabilities’ to the banker.
Using working capital line of credit requires some discipline. If your business proves that it can handle the customary requirements, you’ll put yourself in the best position to be renewed. It will also make it easier to extend a larger line of credit should you find you need that in the future.
If your business is growing, don’t wait until you need a line of credit to establish a good relationship with your bank and your banker. When your banker is familiar with the ups and downs of your business, and has an understanding of how you manage those challenges, it’ll be a lot more likely that they’ll be able to make an affirmative decision when you apply.
At Business Bank of Texas, we pride ourselves on maintaining great relationships with our business clients. If you’d like to talk with us about a line of credit, or any other banking services your business might need, please feel free to contact us at any time.