Cash flow problems are not uncommon for small businesses. The reason can simply be a result of seasonal credit demands or other causes such as time gap between revenue realization and capital needs. Start-ups in early stages of development are particularly prone to this weakness. A business line of credit is one of the most common options available for businesses to solve cash flow issues.
This option often vies with a business loan as a financing tool relied on by entrepreneurs in need of liquidity. Before deciding upon which one should be used, management needs to understand the difference between the two. Knowing when to use each can have a significant influence on growth.
An essential characteristic of a loan is its fixed term. It cannot be renewed, whereas, the LOC may be renewed more than once. Its closing cost is also usually less. A LOC can be set up prior to any realized need. Normally, a specified sum is made available. Just the outstanding amount is reflected in the payment requirements. Usually lines that are secured are made available to less established businesses. More established enterprises may be offered unsecured funding.
Borrowers have the right to repay and reborrow during a time period agreed upon. A borrower only pays interest on the outstanding principal. If you have a late payment or exceed your amount, interest rates will increase. Conversely, you may be able to lower the interest rate. Lenders like to know how a borrower will repay should the first source of repayment fail to come through. They look for sufficient elasticity in operations to accommodate temporary reversals.
It is optimally a palliative for transitory shortages. Businesses can prevail over unforeseen shortfalls by deploying this panacea. Both recurrent borrowing requirements and liquidity fluctuations are fixed by reliance on this support.
Loans are typically sought for a specific purpose. Monthly payment requirements commence on inception. Payments do not rely on whether the funds are used. The repayment period and duration are fixed in a loan. Monthly payments are as a result higher than in the case of a LOC. The closing costs for loans generally can be between 2 and 7 percent; whereas LOCs are not as high.
Insufficient capital can put an end to a venture. With insufficient liquidity, managers run out of vital ability to keep a going concern. It is important to select the appropriate funding mechanism. Using the right tool means determining which one is more suitable for short term demands and which serves long term needs better. Whether a business line of credit is used or not, the goal is productive use of provided capital.
Author: Isaura DowneyThis author has published 3 articles so far.