When managing a small business, payment flexibility and quick access to funds are critical to maintaining financial stability. Small businesses often face slow revenue or cash flow gaps, which is why extra funding can be a snap when things get challenging.
That’s where a small business line of credit comes in—a financing option that’s extra flexible and allows businesses to on demand basis and only pay interest on the amount they withdraw.
However, qualifying for a small business line of credit doesn’t mean you’ll automatically maximize its benefits. In this article, we’ll share some best practices you can implement to ensure you’re truly managing it effectively.
What is a small business line of credit?
A small business line of credit is a flexible financing tool that allows you to borrow money up to a certain limit predetermined by the lender, rather than getting a lump sum payment like a traditional business term loan.
This finance option works on a recurring basis, meaning you can withdraw a certain amount, pay it back and withdraw it again without having to start a new application process each time. Plus, you only pay interest on the amount you borrow.
A business line of credit is typically used for short-term financing needs, such as purchasing inventory, paying unexpected expenses, or managing cash flow.
Managing a Small Business Line of Credit: 10 Best Practices
As we mentioned before, getting approved for a small business line of credit does not guarantee that you will be able to effectively manage it and take full advantage of the benefits it offers. Here are the best practices to ensure you actually achieve this goal:
1. Decide on priorities for key investments
When managing a small business line of credit, it’s important to prioritize investments that are critical to your business. Rather than using your line of credit for day-to-day operating expenses, use it strategically in situations where you can generate positive returns.
This can include purchasing inventory to take advantage of discounts or meet seasonal demand, address cash flow gaps or fund short-term growth opportunities.
By prioritizing high-impact needs over overhead expenses, you can grow your business and maximize return on investment, maintain financial flexibility and ensure long-term sustainability without accumulating unnecessary debt.
Scenario: Clothing store using credit line
Let’s say you have a clothing store where demand fluctuates throughout the year, with peak sales in the summer and slower sales in the winter. You are approved for a $500,000 line of credit from National Business Capital.
By using your line of credit for high-impact needs, such as buying inventory in bulk over the summer and seizing short-term growth opportunities (setting up pop-ups for local events), you can acquire new customers, increase brand visibility, and generate additional revenue. .
2. Avoid over-reliance
Another tip for effectively managing your small business line of credit is to avoid overreliance. Relying on it as a primary source of cash can be risky, as it can lead to the accumulation of long-term debt without generating sufficient returns to repay the debt.
Overutilization means you are effectively borrowing repeatedly to pay for daily expenses, which may not generate enough profit or cash flow to effectively pay down the debt. Without a repayment plan, this debt can snowball, accruing interest and causing financial stress.
Not only will it limit your access to other financing options and affect your credit score, but it will also hinder the growth of your business – which is definitely not the end goal.
3. Minimize borrowing
One of the biggest benefits of a small business line of credit is that it gives you the flexibility to borrow only the money you need at a given time and pay interest only on the amount withdrawn. So make sure you only borrow the amount you need for your specific purpose.
By calculating how much you really need for a specific expense (such as purchasing inventory), you can avoid taking on unnecessary debt. This helps you keep costs low and maintain financial flexibility without putting unnecessary stress on your finances.
4. Plan your repayments
It’s extremely important to plan your use of a small business line of credit before actually starting to draw down the amount you need. Having a clear repayment plan can help you avoid accumulating unmanageable debt.
It can also help you minimize your interest costs – since interest on a business line of credit is only calculated on the amount borrowed, paying it off as quickly as possible can reduce the total interest you owe. Without a plan, you may run the risk of having a stranded balance, resulting in unnecessary interest payments.
Borrowing through a plan can also help you avoid potential financial stress that may arise if you are unable to repay the funds in a timely manner. A repayment strategy ensures you are not caught off guard by a large repayment later on, reducing the chance of falling into long-term debt.
5. Paying more than the minimum wage
While it may be tempting to pay only the bare minimum, this is usually not the best practice since most of the payment will go toward interest and only a small portion will be applied to the actual amount borrowed.
However, if you consistently pay more than the minimum, a larger portion will be used to reduce your principal, allowing you to pay off your debt faster. The faster you reduce your principal, the less interest will accrue over time, which can lead to significant savings.
6. Avoid unnecessary expenses
If you want to manage your small business line of credit, be sure to avoid late payment fees, which are charged if you fail to pay by the due date. These fees can add up quickly, increasing your overall borrowing costs and negatively impacting your credit score.
To avoid them, we recommend using a calendar or automated system to remind you of payment due dates. Depending on the lender, you can also choose to have automatic payments, ensuring you don’t miss a deadline.
In addition to unnecessary fees, it’s important to avoid overage fees, which are charged when you exceed your small business credit line limit. Overextending your borrowing capacity can seriously damage your business score.
7. Limit usage to 30%-50% of your credit limit
Another best practice for managing your small business credit limit is to limit the use of credit to between 30% and 50% of your credit limit, known as your credit utilization ratio.
A lower credit utilization ratio indicates to your lender that you are managing your credit responsibly, that you are not overextended, and that you have sufficient cash flow to manage your debt.
Scenario: Running a catering business
Let’s say you own a small restaurant business and can get a $50,000 small business line of credit. The busiest seasons are summer and the holidays, when you need to buy large amounts of food and hire extra staff for large events.
During the summer, you have to organize catering for large corporate events, which requires you to purchase additional inventory. By simply borrowing $15,000 from a $50,000 line of credit (or 30% of your available limit), you can cover the upfront costs without overextending yourself.
With $35,000 still available, you have flexibility if unexpected opportunities or expenses arise (such as equipment failure or another large order).
8. Maintain a cash flow buffer
Another best practice for effectively managing your small business line of credit is to maintain a cash flow buffer.
By treating your line of credit as an emergency fund or reserve for unexpected expenses, you can maintain financial flexibility should any potential challenges arise. This way, you won’t deplete your credit for small, non-urgent purchases.
9. Regularly check and adjust usage conditions
Last but not least, it’s important to regularly review your use of your credit line to ensure it’s aligned with your business goals; make adjustments as needed to avoid unnecessary borrowing.
Regular reviews can help ensure that lines of credit are used to manage short-term cash flow issues or growth opportunities, rather than becoming a mainstay for day-to-day expenses. This can improve the overall financial health of the business by controlling debt.
Qualify for the National Business Capital Small Business Line of Credit
If you want to qualify for a small business line of credit, look no further than National Business Capital. With more than $2 billion raised since 2007, multiple awards and a team of experienced business financial advisors, we have everything you need to find the best financing option for your project.
Are you ready to get started? Apply here.