What Is a Business Line of Credit Used For?

A business line of credit provides companies with flexible access to funds. It offers a way to manage various financial demands, supporting operations and growth opportunities.

Defining a Business Line of Credit

A business line of credit functions as a revolving credit account, similar to a credit card, allowing ongoing access to funds up to a set limit. As funds are repaid, they become available again, allowing businesses to borrow, repay, and re-borrow without reapplying. Interest is typically charged only on the amount actually borrowed or “drawn,” rather than on the entire approved credit limit.

This flexibility distinguishes a line of credit from a traditional term loan, where a business receives a single lump sum upfront and repays it over a fixed period. With a term loan, interest accrues on the entire disbursed amount from the start. In contrast, a line of credit allows businesses to access capital as needed, making it suitable for managing variable expenses rather than large, one-time investments.

Practical Applications for Businesses

A business line of credit is particularly useful for managing cash flow fluctuations. Businesses often use it to bridge gaps between accounts receivable and accounts payable, ensuring funds are available to cover daily operating expenses even during periods of delayed customer payments or seasonal slowdowns.

Purchasing inventory is another common application, especially for businesses with seasonal demand or those looking to make bulk purchases. A line of credit allows businesses to acquire necessary stock without tying up immediate cash, and as inventory sells, the balance can be repaid, making funds available again for future purchases.

Working capital needs, such as covering payroll, utilities, or rent, are effectively addressed by a business line of credit. It provides the liquidity required for day-to-day operations, ensuring that essential expenses are met even when cash reserves are low.

The line of credit also serves as an emergency fund, offering quick access to capital for unforeseen expenses or repairs. Whether it is unexpected equipment breakdown or property damage, having a pre-approved line of credit means businesses can respond swiftly without lengthy loan approval processes.

Businesses can leverage a line of credit to seize opportunities, such as taking advantage of supplier discounts for early payments or making timely investments in growth. It provides the agility to fund new product launches, marketing campaigns, or even to acquire new customers without depleting existing cash.

Finally, a line of credit can cover minor equipment purchases, allowing businesses to acquire smaller, immediate needs without committing to a long-term loan. This provides flexibility for upgrades or replacements, making it a cost-effective solution for specific purchases.

Qualifying for a Business Line of Credit

Lenders assess business and personal credit scores. Many lenders prefer a minimum personal FICO score of at least 600, with higher scores often leading to better interest rates.

The time a business has been in operation is another key consideration; many lenders require a minimum operating history, typically ranging from six months to two years. Annual revenue and profitability are also scrutinized to determine the business’s financial health and ability to repay. Lenders often look for a minimum annual revenue.

A clear business plan outlining the purpose of the funds can strengthen an application, demonstrating a strategic approach to using the credit. Collateral may also be a factor, as lines of credit can be secured or unsecured. Secured lines of credit require assets, such as inventory or equipment, as collateral, potentially offering lower interest rates and higher limits. Unsecured lines do not require collateral but may involve a personal guarantee from the business owner.

Applicants typically need to provide a range of documentation to support their application. This often includes business bank statements, financial statements such as profit and loss reports and balance sheets, and both business and personal tax returns for recent years. Legal documents and an Employer Identification Number (EIN) are also commonly required.

Operating Your Business Line of Credit

Once a business line of credit is approved, accessing funds typically involves a straightforward process. Businesses can often draw funds by transferring the desired amount directly to their business banking account through an online portal or by writing a check against the line.

Repayment generally involves making minimum monthly payments, which include accrued interest and a portion of the principal. As payments are made, the amount of available credit is replenished, allowing the business to draw funds again if needed, up to the original credit limit. This revolving feature provides continuous access to capital.

Interest on a revolving line of credit is commonly calculated daily on the outstanding balance. This means the interest cost varies directly with the amount borrowed and the duration of the borrowing.