5 Smart Ways to Manage Cash Flow Using a Business Line of Credit

In February 7, 2018

Header image: line of credit and cash flow management
Every business has the occasional gap between expenses and accounts receivables, or needs a sudden infusion of cash for something unexpected. It’s just a normal part of doing business. 

Maybe it’s expensive seasonal merchandise that requires prepayment but won’t generate revenue for another six weeks, or slow accounts receivables when payroll is due… but how the gap is handled can significantly impact daily operations.

A business line of credit (LOC) can be the perfect way to smooth out these rough spots. It also can open the doors to opportunity that would be missed without an infusion of extra money, such as a great price on used equipment or offering a robust bonus to entice a new hire on board. Before you assume a LOC is the best loan for your needs and apply for one, though, it’s important to understand how to use it effectively.  

1. Open a LOC before it’s needed.

A business lines of credit with the lowest possible interest rates or backed by the Small Business Administration can take longer than expected for the application and approval processes, especially if it’s a secured loan with a collateral guarantee.

It’s very smart to apply for one long before it’s needed, so cash flow isn’t interrupted.  

2. Limit how often it’s used.

It’s important to match a purchase with the right type of funding and while an open LOC might be convenient, it shouldn’t be overused. LOCs are intended for short-term loans lasting just a few days or weeks, perhaps ninety days—not years.

For a big-ticket purchase or extremely large cash advance, a different type of funding is often more cost effective.

3. Pay it down quickly and leave it open.

Similar to a credit card but less expensive, a business LOC is not intended to carry a balance for any length of time. They’re best used for short-term funding that can be paid off quickly, allowing the LOC to remain open most of the time for emergency use.

A business can’t use it to manage cash flow if it’s never available. It becomes a liability that drains cash reserves, rather than helping manage its flow.

4. Adjust the monthly payment based on cash flow needs.

Because a LOC can be paid back on a flexible basis, unlike a term loan with a fixed payment, adjusting payments to work with cash flow each month is invaluable.

A business can easily make smaller payments during the off-season or a slow month and larger payments when revenue is flowing, as long as it doesn’t dip below the minimum payment required. This keeps more cash at hand when it’s needed the most.

5. Avoid using it for ongoing operational expenses.

A line of credit is best used for occasional expenses, rather than the continual costs of running a business. Paying for operational expenses with a LOC is likely to leave the credit line continually maxed out, and carrying a big balance.  

Also, it’s a more expensive loan with larger minimum payments than a term loan can offer, leaving the business with less cash to pay for other things.

As an example, smart use of a LOC might be to cover payroll for a few days while waiting for a check to arrive that will pay off the advance, but it shouldn’t fund payroll itself on a regular basis. Consider a line of credit as fuel to get a business over the speed bumps and shortcuts, not through the daily commute.   

Businesses that aren’t yet profitable enough to sustain their expenses might pair a LOC for short-term needs with an SBA loan to pay for daily operations as a smart way to maximize cash flow while it grows revenue, but it shouldn’t use a LOC alone to remain in business.  

6. Consider lifespan of the item purchased.

It’s always a good idea to match less expensive items that have a short lifespan with a short-term loan or LOC, and purchase big-ticket items with a long-term loan that matches the expected lifespan of the items purchased. This ensures a business won’t find itself with two sets of payments and hampering cash flow.

A loan for seasonal merchandise should be paid off with the proceeds from that season, which can make it appropriate for using a LOC; however, purchasing computers should be matched to a three- or five-year loan, so payments end when the equipment becomes obsolete.

Using a LOC to pay off an expensive item that will be used for years will also require much larger payments with higher interest, compared to a fixed term loan using the item as collateral. The wrong type of loan burns through more cash.

Cash flow can be tricky and business banking complex. Most small business owners come into a bank assuming they need a line of credit, or apply online for one without ever speaking to a banker, but it’s not always the right type of loan for their needs.

Always speak to a banker before applying for any kind of loan. Think of them as your cash flow advisor!  

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