When it comes to managing a small business, having payment flexibility and quick access to funds is of vital importance for maintaining financial stability. Small businesses often face slow revenue periods or experience cash flow gaps, which is why extra funding can be a breath of air when things get challenging.
This is where a small business line of credit comes in – this financial option is particularly flexible, allowing businesses to access capital on an as-needed basis and only pay interest on the amount they’ve drawn.
However, qualifying for a small business line of credit doesn’t mean that you are automatically maximizing its advantages. In this article, we will share some of the best practices that you can implement to ensure that you are actually 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 pre-determined by the lender rather than receiving a lump sum like a traditional business term loan.
This financial option works on a revolving basis, which means that you can draw a certain amount, repay it, and draw again without having to begin a new application process each time. In addition, you only pay interest on the amount borrowed.
A business line of credit is commonly used for short-term financing 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, getting approved for a small business line of credit is not a guarantee that you are able to manage it effectively and fully leverage the benefits it offers. Here are some of the best practices to ensure that you can actually achieve that:
1. Prioritize Key Investments
When it comes to managing a small business line of credit, it is very important to prioritize the investments that are key for your business. Rather than using the line of credit for routine operational expenses, aim to use it strategically for situations in which you can generate a positive return.
This can include purchasing inventory to take advantage of discounts or meet seasonal demands, handling cash flow gaps, or funding short-term growth opportunities.
By prioritizing high-impact needs instead of everyday expenses, you can grow your business and maximize your return on investment, maintain financial flexibility, and ensure long-term sustainability without accumulating unnecessary debt.
Scenario: Clothing Store Using a Line of Credit
Let’s say that you have a clothing store that experiences fluctuating demand throughout the year, with peak sales during summer and slow sales during winter. You get approved for a $500k line of credit with National Business Capital.
By using the line of credit for high-impact needs such as purchasing inventory in bulk for the summer season and seizing short-term growth opportunities (setting up a pop-up shop for a local event), you can gain new customers, increase brand visibility, and generate extra revenue.
2. Avoid Over Reliance
Another tip when it comes to managing a small business line of credit effectively is to avoid over-reliance. Relying on it as your primary source of cash can be risky because it may lead to accumulating long-term debt without generating sufficient returns to pay it off.
Overuse means you’re essentially borrowing repeatedly to cover daily costs, which may not produce enough profit or cash flow to repay the debt efficiently. Without a repayment plan, this debt can snowball, accruing interest and creating financial strain.
It can not only limit your access to other financing options and affect your credit score, but it can hinder your business growth – which is definitely not the end goal.
3. Minimize Borrowing
One of the biggest benefits of a small business line of credit is that it gives you the flexibility to only borrow what you need at a given time and pay interest only on the amount drawn. So, make sure to only borrow the amount necessary for your specific purpose.
By calculating how much you truly need for a particular expense – for example, purchasing inventory, you avoid taking on more debt than necessary. This helps you keep costs low and maintain financial flexibility without putting an unnecessary strain on your finances.
4. Plan Repayments
Planning the use of your small business line of credit is extremely important before you actually begin drawing the amount you need. Having a clear repayment plan can help you avoid accumulating unmanageable debt.
It also helps you minimize interest costs – since interest on a business line of credit accrues only on the amount borrowed, repaying it as quickly as possible reduces the total interest you’ll owe. Without a plan, you risk letting balances linger, leading to unnecessary interest expenses.
Borrowing with a plan also helps you avoid potential financial strain that may arise if you are unable to pay back the funds promptly. A repayment strategy ensures you’re not caught off-guard by large payments later, reducing the chance of falling into long-term debt.
5. Pay Above The Minimum
While it can be tempting to pay only the bare minimum, it is usually not the best practice as most of the payment will go toward interest, and only a very small portion will be applied to the actual borrowed amount.
However, if you consistently pay above the minimum, a larger portion will go toward reducing the principal, allowing you to pay down the debt faster. The faster you reduce the principal, the less interest you accrue over time, which will lead to significant savings.
6. Avoid Unnecessary Fees
If you want to manage your small business line of credit, make sure to avoid late fees, which are charged if you fail to make your payment by the due date. These fees can quickly add up, increasing your overall cost of borrowing and negatively impacting your credit score.
To avoid them, we recommend using a calendar or an automated system to remind you of payment due dates. Depending on the lender, you may also have the option to automate payments, making sure that you never miss a deadline.
In addition to unnecessary fees, it’s also important to avoid over-limit fees, which are charged if you exceed the limit of your small business line of credit. Overextending your borrowing capacity can significantly hurt your business score.
7. Limit Usage to 30%-50% of Credit Limit
Another best practice when it comes to managing your small business line of credit is to limit the usage of your credit to 30% – 50% of your credit limit, aka your credit utilization ratio.
A low credit utilization ratio demonstrates responsible credit management to your lenders, demonstrating that you are not overextending yourself and that you have sufficient cash flow to manage debt.
Scenario: Running a Catering Business
Let’s say that you are running a small catering business that has access to a $50k small business line of credit. Your busiest seasons are the summer and the holiday months, which is when you need to purchase large amounts of food and hire additional staff for big events.
During the summer, you have to organize catering for a large corporate event, which requires you to buy additional inventory. By only borrowing $15k out of the $50k credit line – aka 30% of your available limit, you are able to cover upfront costs without overextending yourself.
With $35,000 still available, you have flexibility if an unexpected opportunity or expense arises, such as equipment failure or another large order.
8. Maintain a Cash Flow Buffer
Another best practice when it comes to managing your small business line of credit effectively is to maintain a cash flow buffer.
By treating your line of credit as an emergency fund or reserve for unexpected expenses, you maintain financial flexibility in the case of any potential challenges. This way, you don’t deplete your line of credit for small, non-urgent purchases.
9. Review and Adjust Usage Regularly
And last but not least, it is important to periodically review your use of the line of credit to ensure that it aligns with your business goals; adjust as needed to avoid unnecessary borrowing.
Periodic reviews help ensure that the line of credit is being used to manage short-term cash flow issues or growth opportunities rather than becoming a crutch for routine expenses. This improves the overall financial health of your business by keeping debt under control.
Qualifying for a Small Business Line of Credit with National Business Capital
If you want to qualify for a small business line of credit, look no further than National Business Capital. With $2+ billion financed since 2007, multiple awards, and an experienced team of Business Finance Advisors, we have everything you need to find the best financing options for your project.
Are you ready to get started? Apply here.
