Open a line of credit before you need one

The best time to arrange a business line of credit is when the business does not need it. Lenders extend revolving credit against strength: steady revenue, clean financials, and a balance sheet that can carry the commitment. Wait until cash is tight, and the same lender sees risk instead. This piece covers how lines of credit work, what lenders look for, and how to set one up so it is ready when the business calls on it.

What a line of credit is for

A line of credit is short term liquidity. The business draws when it needs cash and repays as cash comes back in. Interest is charged only on the amount outstanding, though many lenders also charge a fee on the unused portion.

Common uses include:

• Covering the gap between paying suppliers and collecting from customers
• Funding seasonal inventory ahead of a busy period
• Absorbing a slow month without delaying payroll
• Moving quickly on a purchase while longer term financing is arranged

A line is not built for long term assets. Using revolving credit to buy equipment or real estate ties up liquidity the business may need later. Lenders also notice when a line never gets paid down. Long lived assets usually belong in term debt matched to their useful life.

How lenders size and secure a line

The borrowing base

Many lines are asset based. The lender sets a borrowing base from eligible receivables and inventory, then advances a percentage of each. Receivables past a certain age, or owed by related parties, are often excluded. Inventory typically advances at a lower rate than receivables because it is harder to turn into cash. The available amount moves as the collateral moves, and the borrower reports it on a regular schedule.

Cash flow lines

Some lenders underwrite a line on the strength of cash flow and the overall relationship rather than a formula. These usually rest on a blanket lien on business assets and a personal guarantee from the owners. They are simpler to administer but depend heavily on the financial statements.

Terms worth reading closely

A term sheet for a line of credit can look short. The details still matter.

• Clean up requirement. Some lines must be paid to zero for a set number of consecutive days each year. This confirms the line is funding cycles, not permanent needs.
• Covenants. Expect minimum debt service coverage, maximum leverage, or minimum liquidity tests, often measured quarterly.
• Renewal. Most lines are reviewed annually. A line can be reduced or not renewed if results slip.
• Deposit relationship. Banks often expect operating accounts to move with the line.
• Fees. Look at origination fees, unused line fees, and any field exam or audit fees on asset based facilities.

Prepare before you apply

A lender reviewing a line wants to understand how cash moves through the business. Having these ready shortens the process:

• Two to three years of business tax returns and year end financial statements
• Current interim financials
• Accounts receivable and accounts payable aging reports
• An inventory report, if inventory will be part of the base
• A short explanation of the business cycle and why the line is needed

Owners should also know their own guarantee exposure and how a new line fits with existing debt. A line that trips a covenant on another loan creates a problem rather than solving one.

Keep the line healthy once it is in place

A line of credit is a relationship that gets reviewed every year. Draw for the purposes it was approved for. Pay it down as cash comes in. Deliver reporting on time. Tell the lender early if results are going to miss a covenant. Lenders tend to work with borrowers who communicate, and to tighten terms on borrowers who surprise them.

If you are weighing how a line of credit fits alongside your other financing, the capital readiness tool is a useful place to start. To talk through your situation directly, contact us.

Thomas Capital Holdings is not a registered investment adviser and does not provide investment advice or recommend securities. Consult your own advisors about your situation.