Lines of Credit

Understanding and securing unsecured lines of credit.

The number-one reason to open a business line of credit is to gain access to short-term funding. Most businesses use these funds to support financing operational expenses like supplies and payroll, or for increasing inventory. Cyclical businesses often rely on an unsecured line of credit as a source of off-season working capital.

Unlike the majority of small business loans, an unsecured line of credit is not designated for a specific purpose or purchase — it’s a good choice for small businesses looking for ways to better manage cash flow. Funds are typically drawn from the line of credit by using a business checking account, a small business credit card or even a Mobile Banking app.

Understanding secured and unsecured lines of credit

A small business line of credit is typically offered as unsecured debt, which means you don’t need to put up collateral (assets that the lender can sell if you default on the debt). Many unsecured lines of credit come with a variable interest rate and are available for sums ranging from $10,000 to $100,000.

For amounts greater than $100,000, you may be required to secure your line of credit with a blanket lien on your assets or a certificate of deposit.

Where to Go for Unsecured Credit

Thanks to modern lending policies, there are many financial institutions that offer unsecured loans and credit lines. In some situations, you might benefit from working with a lender who specializes in this area. As a matter of fact, you can still qualify for unsecured credit through the U.S. Small Business Administration, also known as a working capital loan. In this case, approval is based on your current assets and liabilities rather than long-term revenue and expenses.

Understanding Lines of Credit

Keeping your small business finances running smoothly can often be a challenge in today’s fast-paced world. Depending on your specific business needs, a small business line of credit could be the simple solution you need to meet your goals for growth — at a pace that’s right for you.

It’s all about cash flow. There are some general rules of thumb you can use to determine the size of the credit line your business can reasonably maintain.

Cash flow: A simple idea (on paper)

Cash flow is one of the most fundamental business concepts: Your business has expenses, so it needs to bring in enough cash each month to meet those expenses. Ideally, in order for the business to grow, it brings in more. But while your expenses may stay relatively stable from month to month, your cash flow may vary from month to month.

Cash flow: Not so simple (in practice)

When your business isn’t taking in enough money to meet your bills, you have 2 main options: pay those bills with any cash reserve the business has on hand or use credit. Because variable cash flow is a very common business issue (and a leading cause of new business failures), a general rule of thumb for any business is to have a cash reserve to cover 6-12 months of expenses. However, we all know that for most businesses this isn’t an option. Try to accumulate at least 2 months of expenses to cover interruptions in cash flow from slow payers and seasonal breaks.

But how big should the line be?

This is where you get to play Goldilocks: You don’t want a credit line that’s too large or too small—you want it to be just right. What “just right” means varies with each business, of course, but as we noted in our article about the 5 C’s of credit, a business typically needs to have $1.25 of income to support every $1 of debt service. You need to be confident that when you draw on that line of credit, your business will be able to readily absorb the resulting debt.

Collateral may affect line size, too

Think about the collateral your business can use to secure the line: real estate holdings, receivables and inventory. Remember that the type of collateral helps determine the size of the line of credit: You may be able to secure a line of up to 40% of inventory value, but up to 100% of CD or savings value.

Bottom line: Be smart

Nobody knows your business better than you. Once you secure your line of credit, be thoughtful about how and when you draw against that line.