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Lines of credit can be useful in certain situations, like when a business needs a balanced cash flow — but, as with any loan, there are risks involved. — Getty Images/ferrantraite

For many business owners, there comes a time when they need access to extra cash. Perhaps there's a large, unexpected expense, or clients are late paying their invoices and you need funds to tide you over. During these times, a business line of credit can be a helpful solution.

A small business line of credit provides flexible access to money that can be used to pay for any business expense that comes up. For example, you may use your line of credit to purchase a new dishwasher for your restaurant, order holiday inventory or pay your staff on time.

Like a credit card, a business line of credit can be used in any amount up to your pre-determined credit limit, and you will accrue interest only on the amount you've withdrawn. For this reason, lines of credit are generally more flexible and affordable than a business loan, since you can control when you withdraw money and in what amount (instead of borrowing and paying interest on a fixed loan amount).

If you think a line of credit might be the right financial solution for your company, read on to learn more about the application process and options available to you.

[Read: A Practical Guide to Funding Your Small Business with Business Loans and Beyond]

A line of credit can be extremely helpful for a business with strong revenue that simply needs a little extra cash from time to time.

How to apply for a business line of credit

While sometimes getting approved for this type of financing can be difficult, the process for applying and using a line of credit is straightforward:

  1. Initial application. To apply for your line of credit, you will be subject to a credit review and annual review. Expect to submit financial statements, bank information, business and personal tax returns and more. According to NerdWallet, traditional lenders often require businesses to have strong revenue and a few years of history to qualify. A larger line of credit may even require collateral.
  2. Usage. Upon approval, you will have immediate access to the full amount of your line of credit. You will only have to make payments when you borrow against it, rather than the monthly or weekly required payments you'd have with a loan. To use your line of credit, simply make a withdrawal and transfer the money into your business checking account. Keep in mind that as soon as you borrow funds, interest will begin to accumulate.
  3. Repayment. Your financial institution will typically set a time frame in which you're expected to repay any borrowed money. As you pay down your principal balance, those funds will become available for re-use. At tax time, you may be able to deduct the interest you pay from your taxes, providing you meet the IRS’s criteria for doing so.

Secured vs. unsecured business lines of credit

Like loans, business line of credit types can either be secured or unsecured. A secured business line of credit involves the borrower offering collateral as a security deposit, such as property, equipment or inventory. With unsecured lines, collateral is not required.

Advantages and disadvantages of a business line of credit

When considering if this type of business financing is right for your business, consider these advantages and disadvantages:

Advantages

  • Balanced cash flow during slow seasons.
  • Interest paid only on the amount you use.
  • Flexible opportunities such as limited time offers given by suppliers.
  • Helps you build your business credit.

Disadvantages

  • Accrual of interest and extra charges.
  • Difficulty getting approved if your business is less than two or three years old.
  • Potential for worsening debt.
  • Borrowing limits are typically low compared to other financing options in the market.

A line of credit can be extremely helpful for a business with strong revenue that simply needs a little extra cash from time to time. Keep in mind that this financial product should be used to cover temporary cash flow shortages. It is not for businesses that are already in debt or don’t think they will be able to repay their balance.

[Read: Does Your Business Need Funding? Do These 5 Things First]

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

Published September 27, 2019