What is a business line of credit, and how does it work?

Business finances can fluctuate and require external financial support; one of the main reasons UK businesses fail is poor cash flow.

One method to support your business financially is to secure a business line of credit.

What is a business line of credit?

A business line of credit is a flexible loan for businesses of all sizes.

It allows businesses to borrow money up to a certain amount when needed, either as a lump sum or in smaller amounts up to the total agreed.

They can either be secured or unsecured.

Secured business lines of credit require you to use your assets as collateral against the loan.

The lender may claim your assets if you cannot repay the borrowed amount.

Unsecured business lines of credit don’t require any collateral.

However, unsecured business lines of credit typically have lower credit limits and may have a higher interest rate than secured business lines of credit.

Business lines of credit can also revolve or have a fixed end date, where you will then need to reapply with your lender to continue to have access to the credit line.

Read our 10 ways to reduce your business costs.

How does a business line of credit work?

Similar to a credit card, a business line of credit gives your business access to a limited fund of money.

As a business, you can withdraw funds from your business line of credit whenever you need and only pay interest on that amount instead of the total amount available.

Depending on your agreement with the lender, your business line of credit may expire after a certain period or will revolve.

With a revolving line of credit, you can reuse the available funds once you’ve repaid them without having to reapply with your lender.

A business line of credit could be helpful to a small business for several reasons, such as short-term cash requirements.

Read our guide on cash flow management.

A business line of credit vs business credit card

A business credit card can be used by business owners as an additional line of credit, providing them with a larger pot of money to make business purchases.

Unlike a business line of credit, a business credit card is commonly unsecured, meaning you don’t need to offer any collateral to secure one.

But because they are typically unsecured, your firm could face higher interest rates and fees when applying for a business credit card than when applying for a business line of credit.

A business line of credit vs bank loan

A common alternative to securing a business line of credit is a bank loan, sometimes known as a term loan.

With a bank loan, firms typically borrow a more considerable sum of money and pay back the entire amount in regular, fixed payments over a certain period.

This is unlike a business line of credit, where you can access a potentially smaller pot of money but can withdraw only what you need when you need it.

Bank loans could be a good option for making larger business investments, such as office space, whereas a business line of credit is better suited for smaller purchases when cash flow is tight.

Read our guide to business loans.

What are the advantages and disadvantages of a business line of credit?

Advantages

Flexibility

A line of credit offers flexibility regarding the amount you can borrow, meaning it can be used for a variety of different purposes.

If you wanted to repay early, you could without incurring any early payment fees.

Quicker to apply for

Business lines of credit are typically quicker to apply for than business credit cards or bank loans.

Some lenders may decide within 24 hours.

Act as a financial safety net

A business line of credit can be a financial cushion when your business’s cash flow is tight.

It could help you with day-to-day purchases or unexpected payouts, such as repairs.

Disadvantages

Higher interest rates

Because of their flexibility compared to bank loans or business credit cards, you may face higher interest rates when securing a business line of credit.

Read our guide on how small businesses can deal with high inflation.

Fixed commitment period

A business line of credit is only available for an agreed, fixed period.

You may need to reapply for a business line of credit with your lender, even if you haven’t accessed the funds, unless you have a revolving line of credit.

Short-term solution

Although business lines of credit can provide your business with a financial cushion, they may not be suitable as a long-term financial solution.

It could be worth setting aside time to explore alternative business finance types if you need long-term support.

How to secure a business line of credit

Securing a business line of credit could be considered a pre-emptive business move – you may want to have one in place before you need it.

This is because applying for a business line of credit when your business’ financials are healthy, and it has a good credit score may increase your chances of being approved and securing better credit terms.

Business lines of credit can be secured through banks, credit unions, or independent lenders.

A responsible lender will likely ask for proof of your business’ financials, including balance sheets, income statements, bank statements, and credit history.

Different lenders may request various documents, so it could be a good idea to ask what you’ll need to provide when shopping for the right lender.