A business line of credit is a flexible loan that businesses can acquire from banks or financial institutions. These loans give business owners the ability to access funds when needed and repay over time.
You pay interest only on the portion of money borrowed for credit lines, irrespective of the sanctioned limit. This is unlike a traditional small business loan where you pay interest on the whole amount disbursed in a lump sum.
When you own a business, business lines of credit can help you tackle several short-term funding requirements, such as maintaining inventory, salary payments or addressing new orders. Also, having access to a business line of credit can help you control your cash flow throughout the year.
Types of business line of credit
A line of credit for businesses come in various forms, tailored to meet the diverse financial needs of businesses. The different types of business lines of credit include:
- Traditional business line of credit: This is the most common type, offering businesses a revolving credit line from which they can draw funds up to a predetermined credit limit. As the borrowed amount is repaid, the credit becomes available again, allowing for continuous access to funds.
- Secured line of credit: In a secured line of credit, businesses are required to provide collateral, such as assets or inventory, to secure the credit line. The collateral provides the lender with an added layer of protection in case of default, making it potentially easier to qualify for larger credit limits or lower interest rates.
- Unsecured line of credit: Unlike secured lines of credit, unsecured lines of credit do not require collateral. Instead, the approval for the credit line is based primarily on the creditworthiness and financial strength of the business. As there is no collateral, unsecured lines of credit may have lower credit limits and higher interest rates.
- Working capital line of credit: This type of line of credit is specifically designed to help businesses manage their day-to-day operations and cover short-term expenses, such as payroll, inventory purchases, and accounts receivable. It provides a safety net for businesses experiencing fluctuations in cash flow.
- Invoice financing line of credit: Also known as accounts receivable financing, this line of credit allows businesses to access funds based on the value of their outstanding invoices. Lenders advance a percentage of the total invoice amount, and once the customers pay, the lender deducts their fees and releases the remaining funds to the business.
- Seasonal line of credit: Seasonal businesses with fluctuating revenue throughout the year can benefit from a seasonal line of credit. It provides additional funds during peak seasons to support increased inventory purchases and operational expenses.
- Short-term line of credit: This type of credit is intended for relatively brief durations, often ranging from a few months to a year. It serves as a solution for temporary cash flow gaps or short-term financing needs.
- Long-term line of credit: On the other hand, a long-term line of credit extends over an extended period, typically more than one year. It is suitable for ongoing financial needs or to support long-term growth initiatives.
The availability of these types of business lines of credit may vary depending on the lending institution and the specific financial situation of the business. Each type of credit has its advantages and considerations, and businesses should carefully assess their needs and financial capabilities before choosing the most suitable option.
Top 10 benefits of a business line of credit
There are several reasons why your company can benefit from business lines of credit.
The most significant advantage of a business line of credit is flexibility, which means you can access cash at frequent intervals, repay them and borrow repeatedly. A business line of credit makes funds available whenever you need them, with a flexible repayment structure.
You can use a business line of credit however and whenever you see fit; to cover gaps in cash flow, for ongoing operating costs or tackle unforeseen challenges.
A global study by BLinC Invest found that around 40% of small enterprises’ financial needs go unfulfilled. In India, the credit gap for this sector is estimated to be around Rs. 25 trillion. However, a business line of credit does not require any security, making it easier for these companies to obtain funding without added stress.
4. Business credit
By availing a business line of credit, you can maintain a good credit score. However, make sure that you continue to make your payments on time and keep a low account balance, and you will likely see your credit score go up. Also, you have the advantage of boosting your businesses’ creditworthiness in the eyes of lenders.
5. Cash outflows
A business line of credit comes in handy when there are frequent cash outflows, and it is difficult to determine the exact need for funds in advance.
6. Business growth
In this challenging and highly competitive environment, a business must adapt to dynamic business needs. A business line of credit keeps your business cash flows smooth. It promotes growth by meeting the changing demands of the market and catering to unforeseen opportunities.
7. Interest rate
Financial institutions offer a significantly lower interest rate for a business line of credit. Furthermore, the borrower only pays interest on the amount borrowed from the total credit limit, reducing the total cost of repayment to the lender significantly.
8. Terms & conditions
Keeping the concerns of businesses at the forefront, some lenders provide adaptable terms and conditions when sanctioning a new line of credit. For instance, Razorpay, one of the leading payment solution-providing platforms in India, charges zero processing and foreclosure fees to its borrowers.
9. Business cycle
A business goes through growth and contraction cycles due to its basic operation, but without enough liquidity, expenses may exceed income. This makes it difficult to keep the business running. In such a situation, obtaining a business line of credit can provide a vital source of funding and help keep the business afloat.
10. Borrowing limit
Based on specific parameters, the leading financial institutions of India sanction a business line of credit with a notably higher ceiling of the credit limit. For instance, Razorpay provides up to Rs. 25 Lakhs of credit limit.
Drawbacks of a business line of credit
While a business line of credit offers numerous advantages , it’s essential to be aware of potential drawbacks that may arise. Here are some key considerations regarding the cons of utilising a credit line for business:
- Debt accumulation: Careful financial planning and repayment strategies are crucial when managing a credit line for business. Without prudence, businesses may fall into a cycle of borrowing, which can hinder long-term financial stability and constrain growth opportunities.
- Impact on credit score: Late payments or excessive borrowing can have adverse effects on a business’s creditworthiness, making it more challenging to secure future financing or negotiate favourable terms with lenders.
- Repayment obligations: Regular payments are necessary to repay the borrowed funds when utilising a line of credit for business. Cash flow constraints or unexpected financial setbacks may make meeting these repayment obligations challenging, potentially leading to financial strain and strained relationships with lenders.
How does a business line of credit differ from traditional business loans?
Traditional business loans provide funds in one shot at the time of obtaining the loan. Here, the interest is applicable on the whole amount of loan disbursed irrespective of the usage of such funds.
However, under a business credit line, interest is applicable only on the borrowed amount and not the entire approved limit. So, you need to pay interest according to your business’s funding needs.
Another parameter for the difference is, loan structure and repayment terms!
Business loans are borrowed for a specific term, say three or four years – or even longer, in some cases. They are repaid in equal monthly instalments – consisting of principal and interest for the entire tenure of the loan.
A business line of credit works differently. In this case, the lender provides a credit limit to the borrower and allows him to utilise the limit for a predetermined length of period. Like a credit card, the borrower can use the amount for making purchases and repay them after a particular period. And, then again use the credit limit over and over again to make other purchases or payments. This provides long-term flexibility to businesses as compared to a loan.
Things to consider while using a business line of credit
Here are the key things to keep in mind when you opt for business credit lines.
- It is best to use business credit lines with long-term loans. This way, both your short-term and long-term financial requirements will be met
- You must always pay the debt on time to maintain a good credit history
- Do not excessively rely on credit lines as it may land you in trouble of getting overburdened with debt
Razorpay Line of Credit
Razorpay, the only converged payment solution provider in India, has emerged as a game changer in the fintech market. With its end-to-end digitised facilities, this platform has made it easier for small businesses to opt for alternative means of capital generation.
Razorpay can be highly effective for enterprises considering applying for an MSME loan. For instance, with its business Line of Credit facility, your business can receive a total sanctioned credit amount of up to Rs. 25 lakhs, with a credit line from which you can withdraw 24*7 as per your need. You can repay & reuse the line again.
- Line set up in just 2 business days with 24*7 cash withdrawals
- No collateral. No hidden charges. No pre closure fees
- Interest rates starting at 1.5% per month: Pay only on what you use & save on interest by repaying early. For example: If you withdraw Rs. 1 lakh at 1.5% and repay in 20 days, you pay only Rs. 1000 as interest.
- You also get 100% flexibility. You can repay in easy EMIs or manually from Line of credit dashboard; use your line again without a new application for every withdrawal.
Don’t run out of cash and don’t stop growing!
Frequently asked questions
How does a line of credit work?
A credit line combines features of both a loan and a credit card. Once approved for a borrowing limit, you can access funds up to that limit in smaller increments, and you have the flexibility to use the money for any financial needs. Unlike traditional loans, lenders don’t scrutinise how you utilise the withdrawn funds.
How does a credit line for business affects your credit score?
Credit scores consider multiple factors, with payment history being the most significant. Consistent on-time payments improve scores, while late payments can hurt them. Requesting a high credit limit may indicate over-reliance on credit, so be cautious. Avoiding credit usage may lead to inactive files and lower scores. Check your credit report for errors regularly to maintain a healthy score.
What are the requirements to get a business line of credit?
The requirements for a business line of credit can vary depending on the lender, but generally, you’ll need:
- A well-established business with a track record of revenue and profitability.
- Good credit score and financial history for both the business and the business owner.
- Collateral or assets to secure the line of credit (not always required but can be beneficial).
- Detailed financial documentation, including tax returns and financial statements.
- A strong business plan that outlines how you’ll use the line of credit and repay it.
Keep in mind that each lender may have specific criteria, so it’s essential to check with them directly for precise requirements.