A business line of credit is considered as a revolving loan that a business can draw a fixed capital amount to meet its short-term needs. Interest starts to accumulate once the business draws the amount, and what is paid back will be available for borrowing once the balance is paid. However, just like with the credit card, a limit is set on the amount the business can borrow.
Most businesses use the line of credit as a financing tool for near-term working capital needs such as inventory purchase, repair of equipment, funding a marketing campaign as well as boosting cash flow, especially during offseason.
Types of lines of credit
There are two types of business lines of credit that one can access. The first is the secured credit line, which requires the businesses to commit some assets as collateral to secure credit. Since this is a short term liability, a business will pledge short term assets such as inventory and accounts receivables as collateral.
The other type is an unsecured business line of credit that does not need an asset as collateral but will need a personal guarantee and general lien. Since this LOC doesn’t need collateral, the business should have a strong credit profile plus a good business record to secure this credit.
How a line of credit works
With a LOC, you borrow a given amount which has a limit, and you can access this amount as required. There is a statement every month showing amount used, including interest payments. But the interesting part is that you only pay interest on the amount used.
Once you repay the amount used, the credit limit will be available for access. You can draw and repay as long as you wish, provided the set limit is not exceeded. Repayment of the credit varies from lender to lender and can either be weekly, monthly or periodic payment as the lender will like. It’s important to note that regular access to the line of credit attracts transaction charges on top of annual fees and interest.