Using a line of credit to finance a small business

Debt financing is money loaned to you or your business, for which the lender has a right to earn interest. Many small business turn to debt financing through commercial banks and credit unions. These institutions will lend a portion of the value of your business’ fixed assets. You can then use this financing to buy inventory or additional fixed assets, or to help your business through a cash shortfall.

Today, let’s look at the line of credit to finance your small business’ needs.

What is a line of credit?

A line of credit is a loan used by the borrower when needed and is usually secured by an asset. For example, a home equity line of credit (HELOC) is secured by the equity in the borrower’s home. A commercial line of credit (CLOC) is a business line of credit secured by company assets like inventory or equipment.

Lenders will usually advance between 50–80% of the value of your accounts receivable plus 50% of the value of inventory — known as a margin formula. There is an agreement between the borrower and the lender on the amount of line of credit, interest rate, and terms of repayment.

Why use a line of credit for small business financing?

Many small business owners turn to lines of credit because they’re convenient. They can be used in emergencies without having to go to the lender to ask for a new loan.

One word of warning: always arrange for a line of credit before you actually need it. Trying to get a loan when you’re already in a cash flow crisis is usually a dead end.

Further reading:

Debt sources of financing for small business