How to Use a Business Line of Credit

September 2016

By Al DeFlaviis

Many businesses, at one time or another, have cash flow deficiencies. These can stem from a large account falling behind in payments to a seasonal increase/decrease in sales, among other reasons.

Even if a company manages its cash flow appropriately today, no one can predict the circumstances the company may find itself in a few months from now. The best thing to do is to conserve capital for these unexpected events, but the second best thing is to obtain working capital line of credit. A company does not need to anticipate cash flow issues to apply for a line of credit, instead think of it as an insurance policy that doesn’t need to be paid until you need it. But the time to talk to your bank about a line of credit is before you experience a working capital deficiency.

A line of credit gives a company the opportunity to borrow on a short-term basis for payroll, to take advantage of inventory discounts and to pay other fixed overhead expenses that are due prior to accounts receivable collections.

Here are some ways to use a line of credit to meet your company’s needs for working capital.

How does a line of credit work?

Interest is charged on the outstanding balance, not on the unused portion of the line. Interest rates are almost always variable and are tied to an index such as the prime rate or LIBOR indices. Once you have established a line of credit, your company can usually advance and repay the line as often as necessary. Lines of credit are usually renewed annually at a time when your company’s annual financial statements have been completed.

How can a business determine what its line of credit should be?

To begin the process, you should first meet with your financial adviser or CPA before arranging a meeting with your banker. Preparing beforehand and gathering your information will allow the banker to better understand your business and determine your capital needs. If those needs are short term, a line of credit may be the appropriate solution, as a line of credit should not be any more than an amount that can be repaid through revenue production within 30 to 90 days. However, if those needs are longer term, another type of loan may provide a better solution. Term loans are used primarily for long-term capital expenditures such as purchasing equipment, buildings, building improvements, etc., and are made for periods of three to 10 years.

How do banks determine what credit line they’re willing to extend?

With a line of credit, the way funds are used is left to the discretion of the borrower, so the bank carries more risk. As a result, a company must have a good business credit rating and a solid company financial history; it is unlikely a lender will approve lines of credit for start-ups or businesses without a track record of financial success. Lenders generally also require collateral to secure a line of credit, which is nearly always asset-based, with equipment and facilities backing the line.

However, credit lines can also be secured by receivables, inventory and by the owner’s personal assets, and it is not unusual for the bank to require a business owner to personally guarantee repayment of the line of credit. When entering credit discussions with your bank, be as open as possible about the financial picture of your company. Be prepared to provide financial documentation including profit and loss statements, balance sheets and company tax returns. Having an inside look at the business not only provides your banker with the confidence to recommend the loan package, but he or she is more likely to lobby on your behalf when the line comes up for approval.

How can a business identify a suitable bank to partner with?

Ultimately, you want to be able to lean on your banking relationship to help your business in good times and in bad, so begin by examining your existing relationship. Has your bank been responsive to your needs, acting not just as a lender but as a partner? If not, it may be time to find another bank.

Look for a banking partner that is the right size and complexity for your needs. For example, a national bank may use an automated scoring system to determine credit. Regional banks are often compartmentalized by market share and industry, and when a business changes or evolves, a different banker is assigned.

Community banks, on the other hand, usually have one person, a commercial relationship manager, who coordinates products and services. That person will understand the needs of your business and create a package of products and services that meets those needs.

Select a banker who understands your industry, as well as your marketplace. You will not only benefit from a line of credit but from your banker’s experience, industry insight and solutions to your company’s financing needs.

Al DeFlaviis is a Senior Vice President and Chief Lending Officer at First State Bank.  Reach Al at 586-445-6615 or