What Is a Line of Credit (LOC) in Business?

A business Line of Credit provides companies with a flexible financing option. This financial tool offers access to funds as needed, up to a predetermined limit. It serves as a valuable resource for businesses aiming to manage cash flow fluctuations, seize growth opportunities, or address unforeseen expenses. A business line of credit offers a dynamic approach to funding, differing significantly from traditional term loans.

Defining a Business Line of Credit

A business line of credit is a revolving credit account, functioning similarly to a credit card but designed for business use. It provides access to a set amount of funds, known as the credit limit, which a business can draw upon repeatedly. Interest typically accrues only on the specific amount borrowed, not on the entire credit limit. As funds are repaid, the available credit replenishes, allowing the business to access those funds again without needing to reapply for new credit. This revolving nature makes it a flexible solution for ongoing or short-term financial needs.

Operational Mechanics of a Business Line of Credit

Once a business line of credit is established, a business can access funds up to its approved limit. Funds are typically drawn electronically, often to a business checking account. Interest charges begin immediately on the amount withdrawn. The interest rate may be variable, often indexed to a benchmark rate like the Prime Rate, and varies widely based on borrower creditworthiness.

Businesses are required to make regular minimum payments, which cover the accrued interest and a portion of the principal. As principal amounts are repaid, the available credit automatically becomes accessible again for future use. This means the total credit limit remains constant, but the available credit fluctuates based on draws and repayments. A business line of credit often has a revolving period, which can last for several years, followed by a repayment period for any outstanding balance.

Different Forms of Business Lines of Credit

Business lines of credit come in various forms, primarily distinguished by whether they require collateral. A secured line of credit demands that the business pledge assets, such as accounts receivable, inventory, real estate, or equipment, as security for the borrowed funds. This collateral reduces the lender’s risk, often leading to higher credit limits and lower interest rates. Conversely, an unsecured line of credit does not require specific assets as collateral. These lines are considered riskier for lenders and typically feature higher interest rates and lower credit limits.

Working capital lines of credit are specifically designed to help businesses manage day-to-day operational expenses and bridge cash flow gaps. They provide quick access to funds for needs like payroll, inventory purchases, or covering immediate expenses. Commercial lines of credit are broader in application, often used for larger business needs or by more established companies. Some lines are “demand lines,” which means the lender can request full repayment of the outstanding balance at any time.

Securing a Business Line of Credit

Obtaining a business line of credit involves a thorough evaluation by lenders, who assess the business’s financial health and repayment capacity. Lenders review both the business’s credit history and the personal credit score of the owner(s). A personal FICO score of 625 or higher is often a common minimum requirement. Businesses generally need to demonstrate a consistent revenue stream, often with specific minimum revenue requirements.

Applicants must provide comprehensive financial statements, including balance sheets, income statements, and cash flow projections. A detailed business plan is also often requested, outlining how the funds will be used and the business’s strategy for repayment. For secured lines, documentation proving ownership and value of the proposed collateral, such as equipment lists or real estate appraisals, is essential. The application process can vary, with some online lenders offering decisions in minutes and funding within a day, while traditional banks may take several weeks.

Maintaining a Business Line of Credit

Effective management of an established business line of credit involves strategic utilization and consistent monitoring. Businesses can initiate draws through various methods, including online portals, check requests, or direct transfers to their bank accounts. It is prudent to only draw the exact amount of funds needed.

Repayment strategies involve making regular payments, which can be weekly or monthly, depending on the lender’s terms. Understanding whether payments are interest-only or include principal is important for planning. Monitoring the outstanding balance, the remaining available credit, and the accrued interest is essential to prevent over-utilization and manage costs. Adhering to any covenants or terms set by the lender, such as maintaining specific financial ratios or reporting requirements, is also necessary to keep the line of credit in good standing.