Meeting Short-Term Capital Needs
A line of credit can be a vital tool for helping small businesses grow, cover expenses or meet short-term working capital needs as they arise, so it’s important to know the proper way to utilize this lending channel.
Every small business, especially in today’s volatile market, faces many challenges in meeting its business needs. For example, seasonality, a shortage of working capital, or an unexpected expense can impact financial stability. In these and many other situations, there is no better tool for a business than the availability of a business line of credit.
Financing a small business isn’t easy. Bank credit lines exist to meet small business owners’ short-term financing needs and can give you a key advantage over your competition. Serving as an extension of your cash position, they are designed to help your company meet day-to-day expenses during a cash flow crunch and allow you to take advantage of opportunities now that you might otherwise need to pass up. A study published in Small Business Economics showed companies that use financing tools versus equity infusions outperform their business competition. And because debts must be paid, business owners are more likely to be better stewards of their businesses if they’re beholden to a bank.
Given the challenges of today’s competitive business market, it’s not only important to have a solid relationship with your bank, but to also understand how to meet your company’s needs with short-term financing — a desired and productive business advantage.
Understand the importance of timing
Once a business reaches $500,000 to $1 million in annual revenues, it becomes necessary to have short-term financing in place. The essential principle is that a line of credit is your business insurance — you want it in place before it’s ever really needed. Too often, small businesses wait until they face an unexpected short-term cash flow shortage before considering the advantages of short-term financing. Additionally, having a bank that understands your capital needs is another positive advantage. A business line of credit can ease any short-term cash crunch.
Make yourself an attractive candidate
The first step in getting a line of credit is a comprehensive cash flow forecast, which means carefully testing cash flow projections to see how sensitive they are to changes in unit sales and revenue.
Another key area to assess is the recurring requirements for short-term capital infusions that may be better served by a line of credit than a fixed loan. For example, a private school might need bridge funding until tuition checks come in for the following school year. An entrepreneur might need money to finance the launch of a new product or service that will tie up cash, but quickly generate a new revenue stream. A business can use a line of credit for needs such as equipment purchases, software upgrades, marketing services, inventory purchases and more. A line of credit is also ideally suited to short-term difficulties such as a disruption of cash flow as the result of the loss of a major customer, or the unexpected rise in the cost of goods or supplies.
Regardless of specific need, a thorough cash flow analysis is a critical ingredient in the successful acquisition of a line of credit. But there are other factors a bank will consider, such as how long you have been in business, a positive track record of profitability, good personal credit, and the availability of collateral to secure a business line.
Get help weathering the current economic storm
In a broad and unanticipated downturn such as the present economic crisis, an existing line of credit can give a business an advantage over competitors. Because a line of credit is, in effect, an extension of a company’s cash position, most financial experts tout it as a vitally important weapon in uncertain times. And particularly when there is fiscal anxiety, a line of credit is highly efficient because the user only pays interest on the amount of capital actually deployed.
The vital message small businesses should take away: given the natural cyclicality of business, have a line of credit in place before you need it. Otherwise, it could be hard to get.
Once you have a business line of credit in place, it should only be utilized for short-term business needs. Never use short-term lines for long-term financing such as facility expansion. It is also important to understand the repayment terms and conditions. And, of course, responsible utilization and repayment will always benefit your business.
back to topAlso In This Issue
- Exit Strategies
- Here's how to handle employee terminations professionally while minimizing your chances of being held liable.
- Forward Thinking
- Consider these retirement savings strategies.