A bank line of credit: Why you need one
A bank line of credit is one of the best things to have if you are a small business. It allows you to draw on pre-approved funds to not only meet routine operating expenses, but it can also be there for short-term working capital needs like plugging unexpected cash flow gaps, growing accounts receivable and inventory issues.
Business owners can borrow up to their pre-approved credit limit at any time and for any reason, usually by simply writing a check. As the credit line is repaid, funds become available for use again as needs arise. Interest rates on credit lines are generally favorable, and having a line of credit can help improve a business’ credit rating.
If possible, it’s a good idea to have a line of credit in place before you actually need one. The process of applying for and maintaining an adequate line of credit amount is sometimes difficult, so give yourself plenty of time to apply for one, or to increase the line you have.
The Flip Side
On the flip side, however, there are some potential drawbacks to a line of credit that you should be aware of. For example, loan covenants may jeopardize the ongoing availability of funds, and it can be difficult to obtain a credit line increase, if needed.
Fortunately, alternative financing options exist for small businesses that need short-term financing but cannot qualify for a bank line of credit, or don’t want to jump through all the hoops that are required. The most common alternative financing vehicles include:
• Full-Service Factoring — Here, a business sells its outstanding accounts receivable on an ongoing basis to a commercial finance (or factoring) company at a discount. The factoring company then manages the receivable until it is paid. Factoring is a well-established and accepted method of temporary alternative finance.
• Accounts Receivable (A/R) Financing — A/R financing is an ideal solution for companies that are not yet bankable but have a stable financial condition. The business must submit all of its invoices through to the finance company. A borrowing base is calculated daily and when funds are requested, an interest rate is charged on money in use. If and when the company becomes bankable later, it is a fairly easy transition to a traditional bank line of credit.
• Asset-Based Lending (ABL) — This is a credit facility secured by all of a company’s assets, which may include A/R, equipment and inventory. Unlike with factoring, the business continues to manage and collect its own receivables and submits collateral reports on an ongoing basis to the finance company, which will review and periodically audit the reports.
While fees and interest tend to make ABL slightly more expensive than traditional bank financing, it can often provide the business with access to more capital, which can be a good trade-off.
Much-Needed Cash Infusion
In the right circumstances, options like these can provide much-needed cash for businesses that can’t qualify for an adequate bank credit line. Other benefits of alternative financing include:
- It’s easy to determine the exact cost and obtain an increase.
- Professional collateral management is included.
- Real-time, online interactive reporting is utilized.
- It may provide the business with access to more capital.
- It’s flexible—financing ebbs and flows with a business’ needs.
Many banks today are working in partnership with alternative lenders because everyone wins: The business receives the financing it needs to grow and prosper, while the bank has a chance to retain the non-credit relationship and develop a future one.
Alternative financing is usually considered to be a transitory, not a permanent, source of financing (though some businesses choose to remain with alternative financing for the long term). Therefore, you should have an exit plan in mind for when to transition from alternative financing to a bank line of credit or loan. This also makes it important to maintain and nurture your relationship with your bank while in this transitory financing phase.
Your banker may be able to refer you to an alternative lender that can provide the right type of alternative financing for your situation. If so, be sure you understand the options available to you, and the pros and cons they offer your business. Then concentrate on using the funds to increase your business’ sales and profitability.
Tom Klausen is the President of First Vancouver Financial Services, Ltd., and a consultant in the small business field. He works with small business owners, lenders, consultants and accountants throughout the U.S. and Canada. For more information, TKlausen@fvf.ca or (604) 988-1490 (in Canada) or (206) 947-0912 (in the U.S.) or visit http://www.fvf.ca.