A business line of credit is a funding facility against which businesses can draw on continuously, as and when they need to. It provides funds up to an agreed credit limit and it differs from regular business loans in the flexibility it offers business owners.
All businesses require finance at some stage. Reasons a business may seek finance include pursuing opportunities for growth, fulfilling orders or to assist with day to day cash flow demands. There are multiple types of business finance products available and each comes with its own unique benefits.
The types of finance available for businesses in Australia share similarities, but it is their differences which can assist companies in deciding which is most suited to their size and stage of growth. It can also assist companies in deciding how best to utilise their access to credit, where it will be most beneficial and how repayment options can be tailored to help them improve their cash flow, rather than cause cash flow strain or further compound existing cash flow issues.
Whilst a fixed-term business loan is the most common form of business lending, over half of small business owners opt for the more flexible option of a line of credit (LOC).
Differences between a fixed-term loan and a LOC
With a fixed-term loan, the total sum must be repaid on an agreed schedule over a given amount of time, plus interest. Often the funds received for a business loan are secured against a fixed asset, such as property or equipment. Whilst this cash up-front may allow for bigger investments to be made, it offers little in the way of repayment flexibility. The repayments are non-negotiable; they must be made without fail and any additional funding requires a further application and credit check.
How does a line of credit work?
A business line of credit differs in that an upper limit is agreed with the lender and this may be drawn down on time and again without further application. The borrower pays back only what they have used and after payment, the approved limit returns to its original amount.
In this way, it is quite similar to an overdraft or a credit card. It is often used to assist with the costs of everyday operational expenses, such as cash flow and inventory.
| Fixed-term loan | Line of credit |
|---|---|
| Lump-sum payment up-front | Approved maximum credit limit |
| Paid back over time | Reuse and repay |
| Regular fixed repayments | Make payments on time and don't exceed the limit |
| Used for a specific reason | Used for working capital and day to day operational expenses |
| Must reapply for additional funding | No need for reapplication |
Where to get a line of credit
Traditionally, for a business line of credit facility, business owners would expect to go and have a face-to-face chat with their local bank manager, taking along with them copies of all of their business financials. These days, there are a multitude of online options out there in addition to the big banks. These fintech lenders can often offer an automated approval service with a higher level of speed and flexibility. Business can access the cash they need in as little as 24 hours without having to leave their own premises.
| Traditional Lender | Online Lender |
|---|---|
| Suited to established businesses | Available to smaller businesses |
| Larger lines ($100k+) | Loan amount from as little as $5k up to $100k |
| Security required (property or business assets) | Security not necessarily required |
| May require the business to open other accounts in addition to the line of credit | Short-term repayments, although line begins again after full repayment |
| Longer set-up (1-2 weeks) | Quick access to funding - as fast as 24 hours |
| Rates 10-25% | Higher rates (30%+) |
| 1-5 year terms | |
| Interest-only payments |
How to qualify for a business line of credit
Whether with a traditional lender or a fintech, there are some minimum requirements they’ll ask for:
- You'll need to have been trading for at least a year
- You’ll have an annual turnover of at least $25k (often more)
- You’ll need a few years of trading history
- Good credit scores are important, particularly for larger facilities
- For larger lines of credit, collateral is required
During the application process, you’ll need to supply the following:
- Your personal and business tax returns
- Your bank account info
- Your business financials (profit and loss statement, balance sheets)
Online lenders typically have less stringent eligibility qualifications but consider this list as the minimum information you will likely be required to provide. Whilst it’s easier to get a loan with an online lender, it does often mean that they have higher interest rates.
Why should you consider a line of credit?
- Cash is made available quickly, usually within 24 hours
- It can help smaller businesses build credit
- No need for reapplication
- It can help address a constant financing need
- It is there for unexpected costs and unique purchasing opportunities
Invoice finance line of credit
Invoice finance offers small businesses a revolving line of credit or upfront funds secured against the value of their unpaid invoices. As payment terms on invoices are often between 30 and 45 days, this means that after supplying a product or service, businesses have to wait for payment. This waiting period leaves them out of pocket and can create gaps in a business' cash flow. There are two main types of invoice finance; factoring and discounting.
Invoice finance, which is sometimes referred to as accounts receivable finance or debtor finance, helps by extending instant funds in the form of a business line of credit to cover this shortfall. It is used for working capital, to meet payroll, purchase inventory and pay for overheads and operational expenses.
To apply for invoice financing, a lender will review a business’ accounts receivable ledger and usually extend a limit of around 80% of the total value awaiting payment. To be applicable for an invoice finance line of credit, a business will usually need to meet the following requirements:
- They invoice other businesses upon completion of work
- They operate within selected industries, such as manufacturing, recruitment or transport and logistics
- They have at least 3 debtors
- They do not have overly aged invoices
- They have a minimum total ledger size of at least $10k
