Many small businesses dealing with poor cash flow or high payroll consider applying for a business credit line.
Here’s some information to help guide you about whether a business credit line is a good idea for your business.
What you’ll learn in this article:
The first question to ask yourself before using a line of credit is this:
Will taking a business line of credit help or hurt my cash flow management & profitability long-term?
Yes, a business line of credit could cover the inevitable expenses, but you want to gear it towards opportunities and growth. Because if you’re getting a business line of credit to fund a loan, you’re only covering up one hole by making a new hole. It’s a never-ending story.
Here’s a chart of general guidelines to see whether to try for a secured OR unsecured line of credit for your business — will it help or hurt your business?
Support growth initiatives. Upgrade machinery, property, system improvements, R&D, etc.
Whether it’s payroll or other operational expenses, it’s often where low cash flow needs help– especially for cyclical businesses.
Fund what is turning your cash flow - Inventory, supplies, etc.
Promote your brand and increase sales down the line.
Lay down a stronger foundation and improve operations - Operating standards, preparing severance payments, software development etc.
The last thing to use a line of credit for is past debt.
Avoid covering long-term expenses (such as insurance, utilities) with a line of credit. You might find alternative loan options specifically designed for that expense that will serve you better.
Business lines of credit are not designed for (big) one-time purchases. Again, you might find loan options specifically designed for that expense that will serve you better.
Similar to covering debt, lines of credits shouldn’t be used to cover credit card bills. Most banks won’t allow this to start out with.
Simply keep in mind – ensuring and managing cash flow is a challenge.
Yes, bills must be paid. But expenses are gone after they’re paid — and don’t leave you with any benefit. Growth stays with you — and in the long-term, helps you solve your business cash flow challenges and become more profitable.
The last thing to cover debt with is more debt.
It’s not always clear cut whether an expense will help you grow or take away from your revenue. This could make it hard to manage business cash flow with your new line of credit.
Before applying for a small business line of credit, or credit line loan alternatives, try this:
This surprisingly simple exercise should take less than an hour, but is critical — not just for small business cash flow management, but for your long-term profitability and growth. This is also an easy guidance system to highlight what your line of credit should reinforce in your cash flow.
Now, you’ll easily see the products that are adding value to your company (in the “generating” pile) and some products that are often surprisingly destroying value of your company (in the “negative” pile).
Don’t have clear books?
You can hire a low cost bookkeeper on Upwork who can crunch the numbers for you in a day or two.
Keep the products or services that are generating value and support those with the new business line of credit. Stop the products or services that are destroying value, since those expenses are being burnt and not staying with you.
This is just one of several powerful ways to evaluate where your cash is going, when analyzing your cash flow.
“Whatever the loan is, look at it as an investment. Only put it where it will bring in more money.”
So you pinpointed where your low cash flow is coming from. And you looked at your margins to determine that you can afford to take a loan or business line of credit. You know that a loan or line of credit is the best way forward.
At this point, it’s critical to look at the loan as an investment. As money pumped into the business to help it grow. I.e., one dollar invested in the loan will yield two dollars in return.
Ask yourself, “What will be the best use of those funds that can guarantee that I can get that money back to us — with interest?”
The main benefit of a business line of credit is the flexibility. Unfortunately, that same flexibility could easily lead to overborrowing. And in the long run, that will hurt your business cash flow.
A smart way to approach this is to be very clear about how you’ll use the funds and repay them — before applying for a business line of credit.
In other words, ask yourself: “how much does the risk of borrowing money cost me?”
How much does it take away from my profit margins?
It’s always about balance.
Calculate the and only cover what will produce for you.
Why are financial ratio calculations so important?
Rule of thumb: Only borrow after calculating your working capital and assessing your business cash flow. Don’t borrow more.
Morris Reichman is the founder and CEO of Payro Finance. Former Vice President at Infinity Capital Funding an alternative finance company, Morris possesses a versatile background in the finance industry. Having spent 7+ years working across global macro operations and start up corporate finance Morris's expertise is in business accounting, risk management and investment analysis. Morris founded Payro Finance to support business owners and ensure their business continuity.