Charles Spinelli: How Does a Business Line of Credit Work?

A business line of credit has more in common with a credit card than with a business loan.

Like a business loan, a business line of credit provides a small business with access to money that can be used to cover any business expense that may arise. Unlike a business loan, however, there’s no lump-sum disbursement made when opening the account that requires a monthly payment.

A business line of credit is subject to annual renewal and credit review and is revolving, just like a credit card: Interest accumulates once you draw funds, and the amount you pay is available to be borrowed as you pay down your balance, explains Charles Spinelli.

Here’s an example of a business line of credit.

Let’s say a bank gives you a line of credit with a limit of $10,000. You withdraw $5,000 to buy new equipment. You’ll only have to pay interest on the $5,000 and can still use the remaining $5,000 if you want. If you then need $5,000 for maintenance, you can withdraw that before you’ve paid back the $5,000, explains Charles Spinelli. The interest is only charged on whatever amount you’ve borrowed.

Common uses for a line of credit

If your business is seasonal, a business line of credit can help cover payroll or overheads in the off-season. If you’re waiting for a client’s payment, a line of credit can cover your expenses in the meantime. You may also use your line of credit to take advantage of a bulk purchase discount, says Charles Spinelli.

Risks of a business line of credit

A line of credit shouldn’t be used to cover for losses, notes Charles Spinelli. If you have to regularly use a line of credit for your day-to-day expenses, your business may have cash flow problems. If financing is a part of your solution, it may be better to use a loan with lower interest rates, such as term loans.

How do you get a business line of credit?

It is advisable to get a business line of credit before it is needed, says Charles Spinelli. You’re more likely to get better terms if you apply for a business line of credit when your cash flow is good.

The lender will ask to see your financials, including income statements, bank statements, and balance sheets. They’ll generally want to see your personal credit history as well. Many lenders won’t approve a line of credit unless your business has been profitable for several years.

How can you keep your line of credit?

You will have to follow some rules to keep the line of credit, notes Charles Spinelli. For example, some lenders may require you to stay above a reasonable amount of debt or maintain a particular net worth.

Charles Spinelli shares important information on human resources in his blogs. Read them on this page.