Explaining business lines of credit and how they work

What is a business line of credit?

A business line of credit (BLC) provides companies with ongoing access to credit. Funds can be withdrawn and paid back at any time. Similar to issuing a credit card, a lender will offer a maximum credit limit to the applicant. Interest is paid on only the credit used and balances can fluctuate whenever repayments are made.

How does a business line of credit work?

Similarly to consumer credit, BLCs are usually accessible via a bank account or credit card. BLCs are not the same as business loans for which the company must pay fixed monthly payments to the lender. 

Funds can be withdrawn at any time and interest is charged only on any money drawn down. Some BLCs are 'revolving' (i.e. open-ended) while others expire after a set period. Lenders will stipulate terms and conditions based on how much a company needs to borrow and whether the credit is secured or unsecured (details later). 

Credit lines can be potentially increased in advance of when funds are needed. Companies will need to consult with their current financial providers to qualify for a line of credit increase.

Secured vs. unsecured line of credit

Secured business lines of credit are secured against assets that the lender can use as collateral in case credit is not paid back in full.

Unsecured business lines of credit are not secured with collateral, which means lenders will be liable for any unpaid debts.

Lenders will typically offer lower interest rates for secured BLCs as they are seen as less risky.

Requirements for a Business Line of Credit

The terms and conditions for a line of credit depend on the borrower's needs, the lender's terms and whether the credit is secured or unsecured.

Companies will have to meet certain requirements to qualify for a business line of credit. 

Collateral (only required for secured BLCs) might consist of assets such as inventory, accounts receivable, or property. 

With unsecured BLCs, where no collateral is required, certain financial information will be needed, including (but not limited to):

• Business credit score 
• Personal credit score (typically only needed for start-up company owners)
• Annual turnover
• Business debt-to-income ratio
• Tax returns
• Historic bank statements

A credit line might be granted to a company only if it can prove it has been operating responsibly for a minimum period. 

Start-ups might qualify for a line of credit with an EIN (Employee Identification Number) but this might require a guarantee such as personal assets or home equity as collateral.

Successful applicants might have to meet additional criteria to keep their line of credit, such as avoiding a certain amount of debt or repaying funds and interest on time.

Uses for lines of credit

Companies can use funds from a business line of credit to fund any expense they have. Lenders do not necessarily care about what the credit is used for, as long as it is paid back.

Some common uses for credit lines include:

• Overheads
• Payroll
• Client payments
• Inventory
• Supplier fees
• Unexpected expenses

By accessing business credit, short-term cash flow problems can be solved and costs can be covered.

Advantages and disadvantages of credit lines

It's crucial for businesses to understand the pros and cons of a business line of credit before deciding whether it is suitable for them.

Advantages of a Business Line of Credit

• Liquidity and cash flow - a credit line provides revolving access to credit to help companies stay on top of expenses and take advantage of temporary offers that might be available only during slower periods when capital is limited.

• Only pay interest on what you use - with a business line of credit, interest is paid only on credit used, not the total amount offered. So, companies can protect themselves against unexpected expenses but also balance risk by accessing credit only when needed.   

• Improve business credit rating - a business line of credit helps companies build their credit rating, thus enabling them to qualify for finance with lower interest rates in the future.

Disadvantages of a business line of credit

• Additional fees - in addition to the interest rates charged on used credit, some lenders may apply extra costs to a business line of credit. These may include annual maintenance or withdrawal fees.

• Complex application process - because an unsecured business line of credit doesn't require any financial collateral, the application process can be complex and time-consuming due to the financial information required. 

• Lower limits - credit lines granted without any collateral might provide companies only with lower credit limits compared with alternative finance options.
  
  

Alternative small business finance options

A line of credit can be helpful for many companies experiencing cash flow challenges or difficulty with paying bills. However, a credit line might not be a good choice for every firm. For some companies, repayment terms may be unaffordable or credit amounts insufficient for their needs. In these cases, there are alternative business finance options that may be worth exploring, including:

Loans

Loans provide access to a set amount of finance which is borrowed as a lump sum, with the borrowing company paying interest on the total amount and not the amount of credit drawn down.

Equipment financing

Equipment finance involves companies taking out a loan to acquire assets or equipment. While that equipment is being used, the company gradually repays the loan plus interest. The assets themselves are being used as collateral for the loan. 

Invoice financing

Invoice financing - or invoice factoring - involves companies receiving an advance payment from a lender on their unpaid invoices. The balance (minus any service fees) is paid on the invoice due date once the debt has been collected. This solves short-term cash flow problems caused by working capital being tied up in unpaid invoices. 

One of the benefits of invoice financing is that businesses aren't accessing money that isn't already owed to them. Companies no longer have to wait for 30-120 days (or even longer) for invoice payments, instead getting most of that money upfront. 

Bear in mind that some invoice factoring companies will offer only 'recourse factoring', meaning the Supplier is liable for repayment of advances if the Buyer does not pay the invoice. 

Stenn's invoice factoring services are offered on a 'non-recourse basis', where we, as invoice factors, assume responsibility for collecting payment from Buyers. 

Which finance should I get?

Hopefully it's clear to see that obtaining a business line of credit has benefits as well as drawbacks. However, while it can be an effective solution for some businesses it might not be the same for others.

Stenn recommends that you consider all suitable types of business finance to see which one best meets your needs.

If you are interested in learning more about invoice factoring, Stenn has a dedicated FAQ section where you can find more information about our invoice financing services. We also provide videos which explain the company and the financing process in detail.

About the Authors

This article is authored by the Stenn research team and is part of our educational series.

Stenn is the largest and fastest-growing online platform for financing small and medium-sized businesses engaged in international trade. It is based in London, provides financing services in 74 countries and is backed by financial giants like HSBC, Barclays, Natixis and many others.

Stenn provides liquid cash to SMEs within the global financial system. On stenn.com you can apply online for financing and trade credit protection from $10 000 to $10 million (USD). Only two documents are required. No collateral is needed and funds are transferred within 48 hours of approval.

Check the financing limit available on your deal or go straight to Stenn's easy online application form.

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Disclaimer: The above article has been prepared on the basis of Stenn's understanding of the subject. It is for information only and doesn't constitute advice or recommendation. Whilst every care has been taken in preparing this article, we cannot guarantee that inaccuracies will not occur. Stenn International Ltd. will not be held responsible for any loss, damage or inconvenience caused as a result of anything published above. All those applying for credit should seek professional advice when doing so.