A financial safety net allows entrepreneurs to cushion speed bumps without paying a high price.
Every business needs a safety net, but not all businesses can afford to have one set aside. To secure some form of insurance for your business, try obtaining a line of credit from a bank.
Even if you don’t have immediate plans to use the credit line, it’s helpful for rainy days or, if your business deals with seasonality. Consider it peace of mind if your cash flow gets tight. You never want to be in a position where you get stuck with expensive loans because you need money in a hurry.
It is important to know that lines of credit ideally should only be tapped to cover short-term expenses that you’ll be able to repay fairly quickly.
I suggest to my clients that when it comes to obtaining a line of credit, the amount should be for about 10 percent of your topline sales or 85 percent of accounts receivable or 50 percent of inventory, whichever is greater.
Also keep in mind that if you already have a line of credit, but your business has grown and your bank won’t increase it, you should find another bank. Remember to always search around for the best deal — advice that goes without saying in all financial transactions.
Why a Credit Line Makes Sense
There’s an obvious answer why you should have a credit line: You have immediate access to cash and money can easily be transferred.
In addition, you only pay back (and pay interest on) the amount you borrow, not the entire amount. That saves you money. Payment options are flexible, too. You wouldn’t have to make a set payment, so in a month where you’re flush with cash, you can pay off or pay a large chunk of the loan; in less-prosperous months, you can make smaller payments.
Even better, many lines of credit are unsecured, meaning nervous business owners don’t have to worry about their assets, whether they’re personal, business or a combination of the two being seized. Of course, if your credit score is suspect, your terms might not be that favorable.
That said, an added bonus is that by successfully and responsibly using a line of credit you can improve the credit score of your business, not to mention keep your personal and business finances separate. An improved score can lead to a better chance of acceptance when you do need a loan down the road.
Watch Out for Pitfalls
Keep in mind that any financial option can be problematic if you’re not careful. Discipline is essential when using a line of credit. Even several relatively small withdrawals can add up and leave you with an unmanageable debt.
As mentioned early, be prudent in shopping for your credit line. Not all lines are equal and extra charges and fees can make seemingly cheap money turn into expensive money.
The review process banks use can be cumbersome as well. Your bank may require financial statements, business and personal tax returns, business documents, and existing bank account information, among other things. You’ll probably need two years of business history to qualify and also undergo a yearly review.
Those are relatively small prices to pay, however, for the added financial piece of mind a line of credit offers you.