If you are a business owner you will no doubt run into temporarily cash shortfalls. This is not to be confused with a lack of profitability. A temporary cash shortfall means that you don’t currently have enough cash on hand to pay for current expenses, but you have the money immediately incoming. This can occur due to net 30 agreements you have with customers, essentially allowing them to pay “same as cash” within a 30 day time frame, which is a very common business practice. Business lines of credit can be very useful in dealing with these temporary cash flow issues. We will discuss how they work in more detail in today’s discussion.
Business lines of credit differ from business loans in two ways. First, you are not given funds upon approval as you would be with a loan. Instead you have an amount of money made available to you, very much like a credit card. Second, you will have access to the approved amount over and over, assuming that you have available credit. So if you use $1,500 on a $2,000 line of credit and then pay off $500 of that, you have $1000 available to you.
Some things to consider when comparing lines of credit and loans are as follows. First, loans can be less expensive than a line of credit for certain types of purchases, like equipment purchased less than 90 day same as cash arrangements or large scale purchases. Second, a business loan is more appropriate for anything you plan to carry a balance on for more than 30 days. One common mistake business owners, and indeed individuals, make is that they continue to add on to their line of credit month after month.
If you are adding more and more on to your line of credit, you need to review your business expenses to get them under control. If you have one time expenses that legitimately need to be put on a line of credit than that is fine. The best way to look at this is, if I had these funds available in petty cash, would I use it in this way. If you stick to that rule you should be ok at keeping your credit line under control.
So, unlike a loan, business lines of credit can be refilled over and over. As they are not for a specific purpose, you should think of them as short term cash flow stabilizers. If you end up accumulating more and more on your credit line, you need to reevaluate your expenses.