Working Capital Lines of Credit
A line of credit is funds accessible from a bank that can be used whenever it is required. The funds are typically used to pay for the ongoing working capital or other requirements of your business. Banks usually offer the line of credit for a renewable period of time that ranges from 90 days to a few years. Banks typically have annual reviews of extended period loans. This review ensures that the loan terms are being met and helps the bank manage its risk exposure. Most loans are standardized in that the maximum amount can vary with your credit and needs, interest rates usually float, and you pay interest on the outstanding balance. The borrowed money is most commonly used for inventory purchases and periodic or cyclical business/inventory fluctuations. The most critical factor from a lender's point of view is the borrower's cash flow. Beware; banks may be able to charge a commitment fee even if the full amount (of the line of credit) is never used. If your business is reputable with a sound credit history, you may possibly be able to get an unsecured revolving line of credit. Small businesses should recognize that a commercial line of credit could become a source of never-ending debt. Small businesses usually quickly use all of their existing credit of urgent needs. The situation is typically that the borrower faces a continuous cash shortage, which forces it to pay only interest on the loan. This means that the principal is never reduced. Almost universally, lenders review working capital lines of credit on an annual or semiannual basis. Most contracts give the lender the right to either renew or called due the debt. Lenders typically want the line of credit to periodically carry a zero balance. Because banking environment is becoming more competitive, a bank may repeatedly renew a maximum line of credit if they are being paid interest on the loan in a timely fashion. Under this situation the line of credit can become an open-ended term loans with a large amount of principal that pose risks to both the lender and the borrower.
© 2001 Missouri Innovation Center