Understanding Business Lines of Credit (LOC)
The main advantage of a Line of Credit is the ability to borrow only the amount needed and pay interest only on the amount borrowed.
How a LOC works:
- Typically, a LOC is for 12 months. It’s short term.
- It’s a pre-set borrowing limit normally used for working capital to operate a business.
- The full amount is available, but does not have to be withdrawn.
- You can borrow and pay back the LOC multiple times over a 12 month period.
- You only pay interest on the amount that you borrow.
- You must be in a position to pay back the full sum borrowed plus interest in 12 months.
- Collateral is required (secured LOC), meaning you guarantee the money you’ve borrowed with some type of asset.
Benefits of a LOC:
- It gives you the capital to cover the cash cycle from purchasing goods through collecting A/R from the sale of goods.
- It provides flexibility for seasonality and allows you to draw on the capital in slower months to pay expenses and then pay it back when sales increase.
When you borrow, borrow responsibly!
- Understand the fluctuations of your business model and when/why you need capital.
- Understand the interest expense incurred when borrowing capitaland be aware of how this expense will affect your bottom line.