Business owner looking into a line of credit

10 Ways to Use a Small Business Line of Credit

10+ min read • Mar 05, 2020 • Grant Olsen

Some forms of small business financing might seem intimidating to entrepreneurs. For example, loans with the Small Business Administration (SBA) typically involve intense paperwork and ample amounts of red tape. Likewise, traditional bank loans have strict requirements and also present applicants with fierce competition.

On the other hand, there’s a select group of financing options that are more much borrower-friendly. This list includes merchant cash advances and ACH loans. Another charter member of the club is a business line of credit.

One of the primary ways a business line of credit makes your life easier is that there are almost no limitations on its use. With other loans, such as commercial real estate loans, startup loans, or equipment financing, there are non-negotiable parameters for how you can spend the money. Entrepreneurs often use these stricter loans to fund their major purchases because the dollar amounts are larger, and the financing is specifically structured in a way that simplifies the transaction.

For smaller purchases of all varieties, a business line of credit gives you a convenient payment method. It can also be used to manage your cash flow, which is difficult to maintain with the scourge of unpaid invoices and the seasonality of many small businesses.

“Entrepreneurs frequently encounter difficulties managing their cash flow as a result of seasonal credit demands and time gaps between capital needs and revenue realization,” explains social media strategist Scott Allen. “This is especially true of business startups during their early stages of development when they have not diversified enough to generate constant positive cash flow. Once the inventory has been purchased, it is necessary to ride out the cycle until accounts receivable have been collected. Without sufficient working capital, a serious cash flow problem could develop.”

While a business line of credit won’t insulate you from the natural ebb and flow of business, it can help to smooth out the ride. It’s a simple way to get capital on the fly, which is often what cash flow struggles demand.

“If your business has a low season and a high season, you may consider spending on credit during the low season to push through to the high season,” says USA Today. “If it takes some time to collect payments from customers after sending out invoices, a line of credit can help you cover any gaps.”

Of course, a business line of credit is more than just a cash flow manager. Here are 10 ways you can use this type of financing to benefit your small business:

  1. Handle big projects: If your business secures a large contract, the euphoria might be tempered by the fact that you’ll need to spend a substantial amount of money to fulfill the obligation. A business line of credit can provide the fuel necessary for you to ramp things up and deliver on the contract.
  2. Equip your business: Small businesses often have big equipment needs. Common examples include worksite tools, warehouse infrastructure, kitchen appliances, and office furniture. Even when bootstrapping, there will always be equipment that’s necessary to succeed.
  3. Fix broken equipment: As the old saying goes, “If it ain’t broke, don’t fix it. Just wait for it to break.” Regardless of your industry, you undoubtedly use equipment for your business. And it can be crucial to have capital available in the inevitable case of that equipment breaking down or failing in some way.
  4. Benefit from early payments: There are times when creditors will offer discounts or other incentives to those who pay their bills well ahead of the deadline. Taking advantage of these early-bird specials can be difficult when they’re not included in your standard budget, but a business line of credit can fill the gap. 
  5. Regular operating expenses: Aside from the major expenses associated with a small business, the day-to-day costs definitely add up. You can use a business line of credit to supplement your funds when the operating costs get to be too much to handle.
  6. Jump on a great opportunity: You can forecast your business expenses for the coming months, but it’s impossible to anticipate when a rare opportunity will arise. When you need to take advantage of such times, a business line of credit could make it possible to take action without overextending your finances.
  7. Build a safety net: Just as great things can come along expectedly, there will also be times when unfortunate events put a dent in your budget. Whether it’s a fire in your kitchen or a catastrophic software issue, it can be advantageous to have a buffer of money available to soften your landing.
  8. Hiring staff: Most small businesses have one or more employees, making staffing a major consideration and expense for any entrepreneur. By leveraging a business line of credit, you can get the financial boost necessary to bring on new staff when necessary.
  9. Enhance your technology: In order to compete in the modern business landscape, you need to keep your technology current. It’s true that you can sometimes get away with using ‘90s-era computers, but your website and any related digital tools need to be professional, efficient, and safe. And that’s only possible with high-quality technology.
  10. Improve your marketing: You can also use a business line of credit to bolster your marketing resources. This approach is mainly a long play, as your return on investment may take weeks, months, or even years. But you’ve got to invest in marketing if you want to stand out and attract new customers.

The Recurring Advantages of Revolving Credit

Regardless of how you choose to use a business line of credit, you’ll benefit from the exceptional versatility. Because it’s a revolving form of credit, you can dip into it anytime the need arises. You only pay back what you borrow, and there’s no pressure to use a dime more than you need. Once the money has been repaid, the full amount is reloaded and ready for future use.

This differs substantially from lump sum forms of financing, such as startup loans or equipment financing. With these loans, you borrow a set amount of money from the lender. It arrives in your bank account in one transaction, and you are obligated to pay back the entire amount regardless of whether you use it or not.

With a business line of credit, you’ll only owe interest on the money you spend. You could be approved for a line of credit worth $40,000, but if you only spent $20,000, that’s all you’d need to repay with interest. With a lump sum loan of the same amount, you’d owe interest on the full $40,000.

If the structure of a business line of credit seems familiar, you’re probably among the millions of people who use a credit card. Your card comes with a limit, then you make as many purchases as you like within that limit. Each payment makes the funds available for future use.

Choosing Between a Line of Credit and a Credit Card

Given the similarities between the various forms of revolving credit, it makes sense that many entrepreneurs enjoy using both a line of credit and business credit cards. Here are some key details to help you make that decision:

Business Line of Credit: With amounts going from $1,000 all the way up to $500,000, you can expect your line of credit to be available about a week after your application is approved. Interest rates start at 8% and can go as high as 24%. Plan on the terms having a 1–2 year maturity.

A business line of credit is one of the easier financing options to qualify for. As long as your business has been running for 6 or more months and you’re bringing in $50,000 a year, you’ll be considered a potential candidate.

While a credit score below 700 can exclude you from some loans, a business line of credit is available even to those in the mid-500s. This is great news for entrepreneurs who have taken risks and felt the corresponding impacts on their score.

As the lender reviews your financial history and the unique details of your desired line of credit, they’ll decide whether or not you’ll need to personally guarantee the financing. With a secured line of credit, you’ll offer up a personal asset as a guarantee. Common examples include homes, real estate, vehicles, or bank accounts. If you make all your payments as laid out in the contract, you’ll never need to worry about this aspect of the financing. But if your business were to default, the lender would use the personal asset to get compensation.

A less common scenario is where the lender does not require a guarantee. An unsecured line of credit is typically only available to those who have impressive revenue and supplemental income sources available.

Business Credit Card: The biggest advantage of a credit card is that you probably already know how to use it. That automatically places it at the top of the heap when it comes to user-friendly financing. You’ll simply take the processes you use with your personal credit card and apply them to your business dealings.

As with a business line of credit, credit cards can come with limits up to $500,000. The rest of the numbers are also similar, with interest rates ranging from 8–24% and loan terms with 1–2 year maturity.

You’ll notice a key difference in the application process, as applicants with credit scores lower than 680 are often turned down. While this credit score requirement is more strict than that of a business line of credit, the financial history and business revenue requirements are fairly similar.

The actual process of applying for a business credit card is a breeze. The paperwork is minimal and there aren’t major demands for documentation. While some loans, such as those from the Small Business Administration (SBA), require you to submit piles of documents, your credit card application is as streamlined as possible.

Many entrepreneurs prefer to use a business credit card for their purchases because it builds their credit and allows them to participate in a rewards program— the day-to-day purchases you have to make can come with kickbacks such as travel points, gift cards, and cash.

“A business credit card can be much more than a convenient way to pay for purchases,” says Forbes. “These cards can also provide lucrative rewards, superior fraud protection, and smooth out cash flow. According to the Federal Reserve’s 2019 Small Business Credit Survey, 52% of firms with 1 to 499 employees use credit cards on a regular basis.”

Identifying the Best Financing Option

Once you’ve decided between a business line of credit and a business credit card (or perhaps opted for both), you’re ready to find the lender that best fits with your business goals. Don’t assume that the financing is all alike. There are good lenders and there are those you’ll want to avoid at all costs.

In order to do your due diligence, you’ll need a business plan. This document helps you determine how much money you need. When you have this amount in mind, you can enjoy a faster process of weeding out the various options available.

“In order to get a small business loan from just about any lender, you have to prepare a good business plan,” says The Balance Small Business. “In fact, until you have a good business plan, chances are you won’t even know how much money you need or how fast you can repay it. The business plan is in addition to the loan application required by the financial institution.”

To get started, look at the credit limit and interest rate associated with any option. This information will help you gauge your ability to comfortably make payments on the money you borrow. Your goal should be to find a financing option that you could handle even if your business were to hit speed bumps. While it’s true that you can make a minimum payment and carry over a balance into the next billing cycle, you’ll owe interest on the unpaid amount. For this reason, this approach isn’t sustainable if the amount due becomes too large.

As you’re analyzing the various financing details from lenders, you may encounter a fair bit of ambiguity. This confusion occurs because some lenders use disclosures that list crucial metrics differently. Even the interest rate might be presented in a way that makes it confusing to compare to other options.

There are free online calculators to help you crunch numbers, but sometimes you need to take it up a notch. One of the best comparison tools available is SMART Box™ (Straightforward Metrics Around Rate and Total cost), which was created by the Innovative Lending Platform Association and some of the top lending platforms.

“Access to capital is a top priority for NSBA and we appreciate how SMART Box allows small businesses to more fully assess and compare lending options,” says Todd McCracken, president and CEO of the National Small Business Association. “This type of price transparency, along with best practices like the ones adopted by the Coalition for Responsible Business Finance (CRBF), will help solidify the trust between non-bank lenders and small businesses.”

Even when you have a resource like SMART Box™, there’s no substitute for careful consideration. Spending a little extra time in the decision-making stage can save you massive headaches down the road. The goal should be to find the financing option that fits your business like a glove. Chances are slim that you’ll find a perfect solution, but never settle for something that doesn’t check all of your boxes.

Securing the Best Chance for Success

Identifying the ideal financing option for your small business is certainly an accomplishment. But your work isn’t over yet. You’ll need to continue your conscientious approach throughout the application process. Because that’s where the rubber meets the road.

Make sure you allow yourself adequate time to thoughtfully review the lender’s requirements. This stage is your opportunity to prove your reliability and instill confidence. Even small errors in the process could throw up a red flag.

Each loan could have unique requirements, but you may want to round up these commonly required documents in advance:

  • Resume
  • Business plan
  • Credit reports
  • Personal and business bank statements
  • Personal and business tax returns
  • Personal financial statements
  • Personal background information
  • Projected financial statements
  • Details of potential collateral
  • Business licenses and registrations
  • Articles of incorporation
  • Copies of third party contracts
  • Franchise agreements
  • Commercial leases

By taking the time to submit a detailed and accurate application, you’ll always put your business in a better position to get approved. When a solid application is combined with a favorable credit score, the result isn’t simply a higher chance of success. It can also qualify you for lower interest rates and better repayment terms. And what entrepreneur isn’t interested in those?

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Grant Olsen

Grant Olsen is a writer specializing in small business loans, leadership skills, and growth strategies. He is a contributing writer for KSL 5 TV, where his articles have generated more than 6 million page views, and has been featured on FitSmallBusiness.com and ModernHealthcare.com. Grant is also the author of the book "Rhino Trouble." He has a B.A. in English from Brigham Young University.