Mastering Your Business Line of Credit: Essential Dos and Don'ts for Success
When utilizing a financial product it is always of paramount importance to ensure that it is used as a tool for success. The misuse of a financial tool, while tempting, can seriously harm your business. The more flexible the product is, the easier it will be to cross the line of inappropriate usage.
One of the most flexible and advantageous financial products available for your business is a business line of credit. While this tool offers so much freedom in terms of what you can use it for, there are some key uses that you will want to avoid. Let’s go through some of the main dos and don’ts of using a business line of credit to ensure success for your business.
What is a business line of credit?
A business line of credit is a type of loan offered by financial institutions to businesses. It allows them to draw funds up to a specified limit as needed, repay the borrowed amount, and re-borrow up to the limit as needed, rather than receiving the total amount of the loan in one lump sum. A line of credit is typically used for short-term working capital needs, such as managing cash flow or covering unexpected expenses.
Dos:
1. Do use your business line of credit responsibly and only for legitimate business expenses.
It can be increasingly tempting when getting a large sum of money for your business to go on a spending spree, but it is crucial that each purchase you make is deliberate and thought out. You don’t want to spend funds on items or services that are non-essential for your business or could be questioned as to even being related to your business, to begin with. With a business line of credit, you only pay interest on the funds that are drawn, so you will want to ensure that the funds are committed to something that will provide a return investment.
2. Do keep track of your spending and make payments on time to avoid incurring late fees and damaging your credit score.
As previously stated, one of the best advantages of a business line of credit is that you only pay interest on the funds that you actually withdraw from the account. It is always important to ensure that you are keeping track of the true cost of capital in relation to your funds, as you don’t want to withdraw more than you can pay back in one set period of time. Doing so could cause you to fall behind on payments which could result in additional fees and harm the long-term success of your business in addition to your personal credit.
3. Do consider setting up automatic payments to ensure you don't miss any payments.
We’ve all forgotten something at one point or another, but you don’t want your business to pay the price for a forgotten payment that could have easily been paid on time. Setting up automatic payments is a great way to hold yourself accountable and never miss a payment, just ensure that you are also aware of the set payment dates and that the account the capital is being pulled from has enough to avoid bounced payments.
4. Do shop around for the best interest rates and terms before choosing a business line of credit.
Choosing a business line of credit is no different from choosing any other financial product or tool, you have full control when deciding who you want to do business with. Never go for the first loan provider that you find, make sure you do your due diligence and are thorough in your research so that you can find the best rates and terms to help your business thrive.
5. Do use your line of credit to manage cash flow, bridge seasonal gaps, or take advantage of opportunities that will help grow your business.
While a business line of credit does offer the flexibility to use it for whatever your business needs, a great tip for success is to use it for some of the business expenses that lenders suggest and that other businesses have had proven success using it for. If you use a business line of credit to manage your cash flow or bridge seasonal gaps then you are setting your business up for success.
6. Do communicate with your lender if you encounter any issues or need to make changes to your credit line.
Communication is the key to success. Ensure that you keep communication open with your lender or broker to keep all parties involved and on the same page. If you think you’re going to be late on a payment or circumstances change with your business then communicate this, some lenders may offer more flexible options or help move payment dates around to guarantee your success. When a business succeeds, so does the lender.
Don'ts:
1. Don't use your business line of credit for personal expenses or to pay off personal debts.
This is a surefire way to set you and your business up for failure. Using your business line of credit for personal debts or expenses can come with severe consequences including, but not limited to, breach of contract, legal action, damage to your credit score, loss of future financing opportunities, and major tax implications. A business line of credit should only ever be used for the expenses of your business.
2. Don't max out your credit line or spend beyond your means, as this can lead to financial trouble and damage your credit score.
Like any financial product, with a business line of credit, you should never spend more than you can actually afford. A business line of credit should be your tool for success, so use it carefully to aid your business. When spending, make sure that you have a well-thought-out plan of how you intend to use the funds that includes how much the cost of the capital is and how long it will take for you to pay back, and if it is feasible to pay back within the set repayment terms of your contract.
3. Don't make payments late, as this can result in fees and hurt your credit score.
Late payments should be avoided at all costs as this could result in hurting your business, yourself, and your reputation. As previously mentioned, when preparing to use your business line of credit, have a plan in place so that you know how much the capital will cost you and when the payment dates will be. Automatic payments are a great way to avoid late fees however they are not out for late payments as you will need to ensure that any account that is used for an automatic payment has enough funds available for the automatic withdrawal.
4. Don't ignore changes in interest rates or fees associated with your business line of credit.
It is crucial that you stay up to date on any and all changes that are associated with your business lines of credit. Make sure that you are reading each email that your lender sends you, as they will need to alert you before making any changes to your agreed-upon interest rates and fees. If rates or fees change then this could affect your overall budget and you may need to make adjustments to the financial planning of your business in order for it to continue thriving.
5. Don't assume that a business line of credit is a substitute for a business plan or sound financial management practices.
While a business line of credit is a great source of relief when experiencing cash flow gaps, it is not a miracle product that solves all of your business’s financial problems. Use it instead as a tool for success or to lengthen your business’s runway and pair it with smart financial management practices so that you can really get the most out of the finances. Remember, a business line of credit still needs to be paid back with interest so have a financial plan built around any instance of use.
6. Don't use your line of credit to finance long-term projects or investments, as this can lead to debt that may be difficult to repay.
A business line of credit works best when used to cover short-term business needs, such as payroll or equipment financing, as covering short-term needs often provides an opportunity to also pay the funds back in a shorter time period. Using it in relation to long-term projects or investments could mean that you won’t see a return investment for some time resulting in you either paying back the loan out of pocket or not having the finances available to pay it back, which can have serious repercussions for your business’s future.
Backd Business Line of Credit
Traditional funding through banks and credit unions has inconvenient and drawn-out lending processes that can take up to months, and their approval rates are usually quite low - that's why we created the Backd solution.
Backd’s business line of credit offers your business the ability to flexibly cover short-term financing needs of up to $750K. Get instant access to revolving credit with competitive terms and the best rate for your business. Backd even uses a soft credit pull so that your credit score isn’t affected during the application process.
At Backd, our application process takes as little as 3 minutes with a soft credit check so there is no impact on your credit score. Typically funds will be sent to you in just 24 hours so don’t wait to secure the funding that your business needs today, get Backd.
