When it comes to running a small business, having flexible payment options and quick access to funds is critical to maintaining financial stability. Small businesses often face down times or experience cash flow gaps, which is why additional funding can be a breath of fresh air when things get tough.
That's where a small business line of credit comes in – this financing option is flexible, allowing businesses to access cash at an affordable rate. the necessary foundation and pay interest only on the amount they have withdrawn.
However, qualifying for a small business line of credit does not automatically increase its benefits. In this article, we'll share some of the best practices you can use to make sure you're really managing it effectively.
What is a Small Business Line of Credit?
A small business line of credit is a flexible financing tool that allows you to borrow money up to a certain limit predetermined by the lender rather than getting a lump sum like a regular business term loan.
This financing option works on a rolling basis, meaning you can withdraw a certain amount, return it, and draw again without having to start a new application process each time. In addition, you only pay interest on the amount borrowed.
A business line of credit is often used for short-term financial needs, such as purchasing inventory, covering unexpected expenses, or managing cash flow.
Managing a Small Business Line of Credit: 10 Best Practices
As we mentioned earlier, being approved for a small business line of credit is not a guarantee that you can manage it successfully and take full advantage of the benefits it offers. Here are some of the best ways to make sure you can achieve that:
1. Prioritize Key Investments
When it comes to managing a small business loan, it is very important to prioritize the key investments for your business. Rather than using a line of credit for regular operating expenses, aim to use it systematically in situations where you can get a good return.
This may include purchasing inventory to take advantage of discounts or meet seasonal needs, managing cash flow gaps, or financing short-term growth opportunities.
By prioritizing high-impact needs instead of day-to-day expenses, you can grow your business and increase your return on investment, maintain financial flexibility, and ensure long-term sustainability without accumulating unnecessary debt.
Situation: A Clothing Store Using a Line of Credit
Let's say you have a clothing store that experiences fluctuating demand throughout the year, with high sales in the summer and slow sales in the winter. You are approved for a $500k line of credit through National Business Capital.
By using a line of credit for high-impact needs like buying inventory in bulk for the summer season and seizing short-term growth opportunities (setting up a pop-up store for a local event), you can get new customers, grow the brand. visibility, and making more money.
2. Avoid Overconfidence
Another tip when it comes to managing a small business line of credit successfully is to avoid over-reliance. Relying on it as your main source of income can be dangerous because it can lead to accumulating long-term debt without making enough returns to pay it off.
Overspending means you repeatedly borrow to pay for everyday expenses, which may not generate enough profit or cash flow to pay off the debt properly. Without a payment plan, this debt can grow, accumulate interest and cause financial difficulties.
Not only can it limit your access to other financing options and affect your credit score, but it can hinder the growth of your business – which is definitely not the end goal.
3. Reduce Borrowing
One of the biggest advantages of a small business loan is that it gives you the flexibility to borrow only what you need at a given time and only pay interest on the amount drawn. So, make sure that you borrow only the amount required for your particular purpose.
By calculating how much you really need for certain expenses – for example, buying inventory, you avoid taking on more debt than necessary. This helps you keep costs down and maintain financial flexibility without putting unnecessary strain on your finances.
4. Schedule Payments
Planning the use of your small business line of credit is very important before you start drawing the amount you need. Having a clear payment plan can help you avoid spiraling into debt.
It also helps you reduce interest costs – since interest on a business line of credit only accrues on the amount borrowed, paying it back as soon as possible reduces the amount of interest you will owe. Without a plan, you risk letting balances sit, leading to unnecessary interest charges.
Borrowing with a plan also helps you avoid difficulties that may arise if you are unable to repay the loan promptly. A repayment strategy ensures that large payments don't hold you back over time, which reduces the chances of falling into long-term debt.
5. Pay Above Minimum
While it may be tempting to pay only a small amount down, it is usually not the best practice since most of the payment will go toward interest, and a very small portion will be applied to the original loan amount.
However, if you regularly pay more than the down payment, a large portion will go toward reducing the principal, allowing you to pay off the loan faster. The sooner you reduce your principal, the less interest you earn over time, which will lead to significant savings.
6. Avoid Unnecessary Fees
If you want to manage your small business line of credit, be sure to avoid late fees, which are charged if you fail to pay by the due date. These fees can add up quickly, increasing your overall cost of borrowing and negatively impacting your credit score.
To avoid them, we recommend that you use a calendar or an automated system to remind you of the payment dates that are due. Depending on the lender, you may also have the option to make payments automatically, making sure you don't miss a deadline.
In addition to unnecessary fees, it's also important to avoid over-limit fees, which are charged when you exceed your small business credit limit. Increasing your borrowing capacity too much can seriously damage your business score.
7. Limit Spending to 30%-50% of Credit Limit
One of the best ways to manage your small business credit is to limit your credit utilization to 30% – 50% of your credit limit, which is your average credit utilization.
A low credit utilization ratio shows responsible credit management to your lenders, showing that you are not overextending and that you have enough cash flow to manage the debt.
Status: Running a Food Business
Let's say you run a small catering business with access to a $50k small business line of credit. Your busiest seasons are the summer and holiday months, which is when you need to buy more food and hire more staff for larger events.
During the summer, you have to plan to cater a large corporate event, which requires you to purchase more inventory. By only borrowing $15k from the $50k line of credit – that's 30% of your available limit, you're able to cover upfront expenses without overspending.
With $35,000 still available, you have flexibility if an opportunity or unexpected expense arises, such as equipment failure or another large order.
8. Maintain a Cash Flow Audience
Another best practice when it comes to managing your small business line of credit properly is to maintain a cash flow buffer.
By treating your line of credit as an emergency fund or saving for unexpected expenses, you maintain financial flexibility in the event of any potential challenges. This way, you don't exhaust your credit line with small, non-urgent purchases.
9. Review and Adjust Usage Regularly
And finally, it is important to periodically review your use of a line of credit to ensure that it is consistent with your business goals; adjust as needed to avoid unnecessary borrowing.
Periodic reviews help ensure that the line of credit is used to manage short-term cash flow problems or growth opportunities rather than as a means of regular expenses. This improves the overall financial health of your business by keeping liabilities under control.
Qualify for a Small Business Line of Credit with a National Head of Business
If you want to qualify for a small business line of credit, look no further than National Business Capital. With $2+ billion in funding since 2007, multiple awards, and an experienced team of Corporate Finance Advisors, we have everything you need to find the best financing options for your project.
Are you ready to get started? Apply here.
