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How to Get the Most Out of Your Commercial Line of Credit
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Here John provides the first article in a series about the ins and outs of commercial lending, loan management, and business finance best practices.
When things are going well for your business, it can feel like you’re flying high. But if you hit a pocket of unanticipated expenses, the dip in your cash flow might have you looking for parachutes.
That’s where one of the most common types of business or commercial lending, the line of credit, can come in handy. The line of credit is revolving in nature, meaning that it doesn’t have a set repayment term, and you can take cash out and put it back basically as you please so long as you make small minimum monthly payments.
A line of credit offers flexibility and quick access to liquidity, but it can be misused, which can lead to turbulence either for your company or for your relationship with your bank.
How to Avoid Turbulence
Businesses generate revenue on a daily basis, but most (outside of retail) do not receive that revenue as cash at the same time that it’s generated. Instead, the revenue generally becomes accounts receivable (AR).
AR is a promise to pay in a certain span of time; such as 30 days. For example, if a customer purchased something from you on July 1, they would get the benefit of receiving that product or service today but would have until August 1 to pay for it. This is very convenient for the customer of course, but not for your business.
In addition to generating revenue every day, most businesses also generate costs and expenses. While you too may be able to purchase things on AR, some vendors will require payment immediately. That’s where timing issues with when your money can make things complicated.
Not having sufficient and liquid funds can prove catastrophic to a business. Bills are defaulted on, services stop, employees quit, and the whole company is endangered. Rather than constantly monitoring your cash flow to make sure its sufficiently flexible at all times, a line of credit (LOC) offers a convenient alternative. Using a LOC as a liquidity reserve to finance your costs and expenses allows you to be more strategic with your cash and gives you the assurance that you will not miscalculate and have a cash shortage.
Coming In for a Successful LOC Landing
The best way to utilize your LOC is to use it to pay all of your day-to-day bills, letting it be your liquidity reserve and leaving your cash for more strategic things. Then as you collect on your AR, use the appropriate portion to pay off the LOC.
Following this strategy, your cash is net of all costs and expenses, meaning it is true liquidity, and not a temporary balance that may shrink when a bill comes in. This allows you to take your profit and confidently use it for the things you want to use it for; whether that’s buying new equipment, funding growth initiatives, or paying yourself or others more.
See this strategy in action with the second article in this series: Financing Your Operating Cycle.
If you’re ready to explore using a LOC for easier cash management (a great way to ensure peace of mind for you and your bookkeeper!) reach out to your local First Bank business banker today. Your options will be tailored to meet your specific needs, and rates remain low*.
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*Loans subject to credit approval.