Seasonal credit demands and gaps between revenue and operational needs can create difficulties for managing cash flow. This is especially true if you are in the early stages of starting your business and have not generated enough activity for constant inflow of money. Even if you have been in business for several years, there are times when the collection cycle on accounts receivable outlasts available cash on hand.
Before surrendering to insufficient cash flow, consider applying for a business line of credit. There are financial institutions that recognize the money you have on paper will soon convert to cash. This is a great financial tool that will accommodate seasonal credit demands. You can also use a line of credit to buy inventory to cover projected sales.
A business line of credit is a borrowing agreement between a financial institution and business. Generally, this is a standard service provided to serve the financial needs of small businesses. Some lenders will extend a secured line of credit, which requires that you to put up collateral such as securities or business assets. Others may approve an unsecured credit line that does not involve collateral. To qualify for an unsecured line of credit, you will need to meet certain criteria that include demonstrating consistent earnings.
Lowering your requested amount for the line of credit may increase your chances of being approved for an unsecured business credit line. However, if the bank insists on giving you a secured line when you prefer an unsecured one, consider applying with an alternative lender with better terms.
Whether secured or unsecured, the business line of credit allows you to draw money from the account as needed. The borrowing agreement includes a maximum amount and borrowing period in which you can borrow and repay.
Typically, getting approved for the line of credit will depend on a demonstrated ability to repay the loan. Some lenders might want to consider your personal assets as part of the approval process. Lenders prefer to see more than one repayment source if your first source does not come through. For instance, you may borrow from the line of credit to buy inventory to cover projected sales. If the inventory does not sell as you projected, you will need to have secondary repayment sources to still repay the loan on time.
In addition, some financial institutions may expect you to pay down the line of credit if you fail to follow the payment schedule. Similar to accelerated payment, you might be required to pay the total even if it is not due for several months. Traditional banks usually will not approve lines of credit to manage business cash flow; nontraditional lenders may have more flexible terms that allow you to use the line of credit for any business need, including cash flow problems.
Tips for Establishing a Line of Credit
If you do not currently have one, write a comprehensive business plan. This should give a detailed description of your business, your goals and why you need the business line of credit. You will also need financial statements to provide a clear financial picture of your business. If requested by the financial institution, you will also need to gather personal financial statements.
For your business, be prepared to present:
The balance sheet will show current assets and liabilities, which should be separated from any long-term assets and liabilities. Equity information your company should be appropriate for the type of business entity that you have such as a corporation, sole proprietorship or limited liability company. A profit and loss statement should represent one year and could be compared to the previous year. Providing two years might be useful to show a favorable trend form one year to the next.
Traditional banks will also want to see cash flow statements, which could be prepared through an indirect or direct method. Other methods are acceptable that could provide more details if you want to make additional information available. With more detail, the lender will have a better picture of your company’s financial status. While more information could be beneficial, the same might also prompt requests for more details.
As an alternative to submitting a full set of financial statements, you could assemble data for a cash or tax basis accounting method. This would eliminate the need to provide the statement of cash flows.
Before applying for the business line of credit, determine the amount that you will need. This number could change based on qualification criteria, but at least you will have an idea of how much is enough – or not enough – should the lender want to approve your business for a different amount. It is also a good idea to check your business credit report for errors that could impact the lender’s decision. Resolve any discrepancies before applying for the credit line.
If the lender rejects your application, or if you do not like the terms of the line of credit, find ways to improve the company’s financial standing. Opening corporate accounts with suppliers that report business credit information might help.
Consider supplementary information that could support your basic financial statements. In some cases, a detailed schedule of gross profit based on a product line might change the outcome. Some lenders may want to see aged receivables or payables that could support information on a balance sheet.
Some nontraditional lenders may approve a business line of credit for your company based on accounts receivable. This could be a viable alternative if you are turned down by a traditional lender – or one that you prefer. Typically, this type of line works the same as what you would receive in a business line of credit. The difference is that your approval amount is based on your company’s revenue.
To illustrate, a retail store could use the average of check, cash and credit card sales it receives each day to obtain a line of credit. Once the amounts are verified, other financial statements such as business checking account activity and a profit and loss statement might be required.
Obtaining a business line of credit is a good financial tool for covering seasonal operating expenses. You can also use the line to cover working capital needs as they occur. Most new business ventures are not eligible to receive a line of credit without a personal guarantee.
Be prepared to provide personal collateral to secure the loan unless the bank is satisfied with your sources of repayment. If your company is structured as a corporation or partnership, the financial institution may collateralize the loan from information on all the principal owners.
Whether you need to maintain or expand your company, you can have financial freedom with a business line of credit. Your chances of being successful can change dramatically with constant access to cash flow. Take advantage of updating old equipment, investing in new technologies, get discounted prices on inventory and even have an emergency fund. Research guidelines from various lenders before making a decision to make sure the terms are agreeable with your business goals.
