Why Understanding Business Line of Credit Requirements Will Make You a Better Candidate
While business loans are a popular choice to finance small business growth and operations, they are not the only option. Many businesses prefer to open a business line of credit or to use one in tandem with other types of financing. Business lines of credit can be easier to obtain than small business loans and they can help companies establish and build a business credit history. Understanding business line of credit requirements can help your company become a more favorable candidate.
What is a Business Line of Credit?
A line of credit is a type of financing that helps businesses meet short-term financial needs by offering an ongoing source of funds that can be accessed when required. Different than a loan, which gives a company a lump sum of money at one time, with a business credit, banks offer companies a set amount of money that they can use little by little as warranted. This approach is preferential for many reasons, most notably because the company only has to pay interest on the portion of the funds it has used. Companies use business lines of credit to purchase supplies and inventory, to cover operational expenses during a gap in cash flow, or to take advantage of unexpected opportunities.
With a credit line, the interest rate is typically tied to the variable market rate. That means it will fluctuate from month to month. A company’s monthly payment will also vary from month to month depending on how much of the credit line has been used.
How to Get a Line of Credit for Your Business
Understanding business line of credit requirements will help prepare your company for a successful application.
Having a strong credit history is not only one of the business line of credit requirements, but it’s a requirement for almost any type of business financing. A good credit score shows the bank that you can responsibly manage debt and have a solid track record of paying your bills. It can be difficult to build a credit history when you’re just starting out, but with a few simple actions, your business can set itself up for future financial success:
- Open bank accounts in the name of the business, even though it might be simpler to use your personal accounts at the start.
- Take out a business credit card in the name of the company. Use it sparingly and pay it off on time. If you can’t pay it off completely, at least pay the minimum balance. Keep your debt ratio in check, i.e., don’t max out your credit cards.
- Ask vendors and suppliers if you can pay on terms (e.g. net 30). Always pay on time or early, if possible.
- Get your business registered with appropriate licenses as required in your local area.
- Get an Employer Identification Number right away, even if you don’t have employees at first. This is like a Social Security Number for your business.
- Obtain a dedicated address (even if it’s a P.O. box), phone number, and website for your business. Put utility bills in the name of the company and pay them on time. This will go a long way in establishing its history, which can impact your business credit.
Positive Cash Flow
In order to get a credit line, your business needs to demonstrate that it has enough money coming in to pay back what it borrows. Banks will look at all aspects of your business performance, including your past, current, and projected earnings. Along with your credit score, these elements are an essential part of the business line of credit requirements. They will determine whether or not you qualify for a line of credit, how high the limit will be, and what the interest rate will be.
If you don’t qualify for an unsecured business line of credit due to a poor credit history, some banks will offer a secured line of credit. This means that the line of credit is backed by the personal collateral of the business owners or collateral owned by the business. Collateral can be any asset of significant value – usually machinery, real estate, or vehicles. If the business defaults on the repayment of its credit line, the bank will be able to seize the assets used as collateral and sell them to make up part of its loss. Clearly, there is some risk involved with a secured line of credit, so be sure to consider whether you can deal with the potentially negative consequences before signing on the dotted line.
While it might not seem intuitive, the best time to apply for a credit line is well before you actually need the money. If you apply early on in your business’ operational history, a bank may offer you a small credit line with a less than stellar interest rate. Take whatever you can get and find opportunities to use it, even if you don’t really need it. Then, pay it off immediately. This will demonstrate fiscal responsibility on the part of your business. As a result, it’s likely your bank will continue to increase your credit limit and improve your terms over time.
Additionally, if cash flow is tight and you are falling behind on your debts, a bank is less likely to give you a credit line even though that is when you need it most. Understanding business line of credit requirements and having the foresight to apply for one early in the life of your business is a smart move and one you will certainly appreciate in the future.
How Difficult is it to Get a Credit Line?
Getting an ideal credit line – one with a high limit and a good interest rate – can be difficult, especially if you apply when your business is young or when your finances are not in perfect health. Banks don’t want to take risks on borrowers who don’t meet a majority of the business line of credit requirements. So the terms they offer will reflect that. It is much easier to accept whatever type of credit line you’re offered and use it responsibly to earn a better rate and a higher limit. At the same time, if you’re not comfortable with what the bank is offering, shop around. Different lenders have different business line of credit requirements and policies.
Putting up collateral to secure your line of credit will make banks more willing to work with you. Even though it brings more risk for the business and its owners, a secured line of credit can be a good place to start. Paying promptly can help build your credit history and improve your credit score. Later, you can parlay that into an unsecured line or another type of financing such as a small business loan.
Traditional banks tend to be slower and more discriminating when it comes to offering business credit lines. Alternative lenders move at the pace of the Internet, so applications are reviewed more quickly and credit lines are funded fast. Some alternative lenders also consider non-traditional criteria when determining if your application is accepted, including a strong business plan or a preliminary purchase order.
Whether your business is brand new or well established, having a business credit line is a prudent choice. It can enable you to take advantage of unexpected opportunities or to survive a challenging time. If you haven’t yet applied for one, make it a priority today.