Can You Get a Line of Credit to Start a Business?
Starting a business is no small feat. It can be exciting and overwhelming all at the same time. When starting your own business, one of the most important questions you have to ask yourself is how you plan to fund it. While your initial thought may be to take out a loan, one other option that many entrepreneurs use to finance their business is a line of credit.
A line of credit is a funding option where a lender provides you with a set amount of credit you can spend. Basically, it is the same concept as a personal credit card, except that business lines of credit generally have higher limits and different interest rates. With a business line of credit, you can spend only what you need and pay it back over time. There are lots of things to consider when it comes to determining the best business line of credit for a new business. For example, small business line of credit requirements and business line of credit rates will vary from lender to lender. In the following guide, we are going to answer some common questions to help you determine if a line of credit is right for you and what other factors you need to consider.
Is a Line of Credit a Good Idea for a Small Business?
A line of credit is certainly a good source of funding for small businesses to consider. In particular, lines of credit have several distinctions from traditional loans that might make them desirable for a small business owner. These include:
The ability to borrow any portion of your total credit limit at a time, pay it off, and then borrow it again.
Credit lines can be used for any purpose, whereas loans might have limitations.
Interest on credit accrues only on funds that are accessed, as opposed to loans which usually charge interest on the entire sum from the start.
Credit lines generally have minimal or no closing costs, compared to loans where closing costs can account for up to 5% of the overall loan amount.
When Should a Business Use a Line of Credit?
A line of credit can be used for practically anything, but there are some considerations that should influence what you spend your money on. For starters, you never want to spend beyond your available credit limit. In other words, if your line of credit is $100,000 and you have already spent $70,000 without paying it off, you should keep your remaining purchases under $30,000. Think of it like overdrafting a bank account. If you spend more than you have available, you can expect some consequences.
Aside from staying within your credit limit, there are other factors to consider when using your line of credit. For example, the type of expense might impact whether you want to put a purchase on credit or not. Typically speaking, most business owners prefer to use a line of credit for short-term expenses and unexpected costs.
How Much Line of Credit Should a Small Business Have?
Simply put, a small business should have enough credit to supplement its cash flow as needed. It can seem difficult to determine how much credit your small business will need, but in reality, there are a few helpful tricks for getting started.
One formula you can use to estimate your credit requirements is to take your daily cash need and multiply it by the number of days in your cash conversion cycle. In other words:
Divide your estimated annual revenue by 365 days in the year. This gives you your daily cash need.
Determine your cash conversion cycle by adding accounts receivable days (how long it takes to collect) to days (how long items spend) in production and inventory, and then subtract the accounts payable days (how long you have to pay vendors).
Once you have your cash conversion cycle, multiply it by your daily cash need. The answer is a good estimate on how much credit you could use.
To really illustrate this, let’s take a look at an example.
Annual revenue estimate: $1,000,000
Accounts receivable days: 45
Production and inventory days: 35
Accounts payable days: 30
Divide $1,000,000 by 365. We get $2,739.73 as a daily cash need.
Add 45 and 35, and then subtract 30 and we get 50 days as our cash conversion cycle.
Multiple $2,739.73 by 50, and we get a credit need of $136,986.50
Is It Hard to Get a Line of Credit for a New Business?
Getting a line of credit for a business can seem somewhat challenging or complicated, but it doesn’t have to be. At Backd we offer quick and easy small business funding solutions. We can provide instant access with unlimited terms. Not to mention our interest rates are tough to beat. All you need to qualify is:
A minimum FICO score of 600
At least one year of business operations
At least $25,000 in monthly business revenue
To be a U.S.-based business
Do you meet these criteria and want to get started?