A business line of credit is a financial borrowing agreement between a business and a financial institution such as a bank. Many businesses use a business line of credit to expand, provide stop-gap funds, or purchase seasonal inventory. Depending on the current financial market, the size and success of the business, and bank regulations, the size and terms of the line of credit may vary.
There are many reasons why a business line of credit can be an asset to a company. For seasonal businesses, such as ski shops or swimsuit boutiques, a line of credit can provide operating expenses during the off season and create capital to buy seasonal merchandise. For expanding operations, a business line of credit can allow an owner to pay for construction, increase inventory, and cover expenses before the expansion is completed.
Many business lines of credit are unsecured, meaning that collateral is not required to get the deal. This can be a relief to many business owners who are afraid to put their business or personal property up as collateral, since they could lose the property if the credit is not repaid. Most financial institutions will require proof of ownership and a detailed revenue history to ensure that the business is not already in serious financial trouble. Revenue success may determine some of the terms of the line of credit, and may increase or decrease maximum amount of that can be borrowed.
A business line of credit differs from a loan in distribution and repayment options. In a loan, the money is given as a lump sum, and the borrower is responsible for making payments on the entire sum within a given time period. Most business lines of credit are revolving; the borrower can withdraw as much as needed up to the maximum allowed, and is only responsible for payments on the amount borrowed. Interest rates on a line of credit are generally variable depending on the market, while loan rates may be fixed.
The downsides of a business line of credit are similar to those found with other credit agreements. Some fees, such as withdrawal or transaction charges, early repayment penalties, or enormous late charges, may raise the total cost of a credit line considerably. A large shift in the economy can send interest rates skyrocketing, leading to much higher payments. If a business does not perform as well as expected, repayment can become impossible, leading to higher total debt and possible bankruptcy.