The popularity of business lines of credit is rising day by day, especially among small and medium businesses. According to Charles Spinelli, LOC has appeared as a powerful funding tool for businesses to have easy access to a revolving form of fund. In this scheme, the borrower needs to pay interest merely on the amount withdrawn, and repaying the money helps in accessing the funding option once again. However, before opting for a business credit line, it makes sense to weigh both its advantages and limitations to determine its suitability for the business. So, keep reading
Pros
Flexibility in Accessing Credit: A LOC allows businesses to borrow funds up to a pre-agreed limit with the freedom to use as much out of it as they need. This unique flexibility makes it ideal for buying machinery, managing cash flow or even catering an unexpected big order, or using it for its optimal growth. Compared to traditional funding, LOC lets businesses draw and repay funds according to necessity, making it a super versatile funding option.
Pay Interest Only on Used Funds: The second notable benefit of LOC is that it requires businesses to pay interest only on the portion of credit they actually use and not on the whole credit limit. Unlike other credit options available where interest is required to be paid on the entire loan amount, irrespective of its usage, this advantage of LOC offers significant cost savings.
Greater Cash Flow: While almost 70+ small businesses experience a lack of required cash flow, seeming as a major barrier to their growth, opting for a LOC can be a great way to smooth their financial ups and downs throughout the year. Charles Spinelli considers drawing a credit line during off-seasons and repaying it in the course of profitable times can help maintain a considerably stable cash flow and avoid disruptions in operations while maintaining a consistent growth rate.
On-demand Access to Funds: On approval of a business LOC, businesses get fast access to funds. This becomes especially beneficial, particularly during the time-sensitive need for finances. The convenience of drawing funds from the business line of credit is not only faster but also an efficient way compared to applying for a traditional loan every time whenever business needs funds.
Opportunity to Boost Credit Score: When LOC is used responsibly by making minimum dues timely and maintaining a credit utilization ratio – it can have a positive impact on one’s business credit score. An appealing credit history can enhance the company’s creditworthiness, making them valuable customers to potential lenders.
Cons
Variable Interest Rates: Noteworthy, business lines of credit offered by many financial institutions come with variable interest rates, signifying potential fluctuations in the cost of borrowing based on market conditions. This variability is likely to make it potentially challenging to anticipate and manage outlays on interest expenses, resulting in higher outlays when rates of interest rise.
Additional Costs and Fees: Although interest is levied only on withdrawn funds, in general almost all business lines of credit involve other charges including annual fees, drawing fees, processing fees, or maintenance fees. These expenses eventually accumulate and eat away the financial benefits of opting for a line of credit. This makes it vital to understand all fee structures before choosing a lender.
Chances of Over-Reliance: Having easy access to a business credit line can potentially lead to the tendency of an increased reliance on loaned funds, which can increase the likelihood of falling into a debt trap over time. While using it can help build credit scores, it can hurt the credit score of the business negatively, when not used thoughtfully.
In a nutshell, businesses should assess their financial needs with diligence, evaluate the terms offered by lenders, and consider how an LOC fits into their overall financial strategy before making a decision. Balancing the pros and cons will help ensure that a business line of credit serves as a valuable tool rather than a potential pitfall.