It’s estimated that nearly 50% of small businesses have a line of credit (LOC) in place, and about one-third utilize it on a regular basis.1 If you’re thinking of an LOC, here are some factors to consider when determining which type is most appropriate for your needs.

The benefit of an LOC is that you are able to borrow money when you need it — and only as much as you need — so you are only paying interest on the money you have borrowed. In addition, the debt repayment schedule is flexible because the minimum payment due is typically interest only. Business LOCs are considered short-term loans, with interest generally due on outstanding amounts monthly and a specific loan maturity period (typically one year, but could be on demand).

Working Capital and Capital Expenditure Lines of Credit

Two common LOC types are working capital and capital expenditure (also known as CAP-EX.) With either, a bank typically will have a first lien position on the borrower’s business assets and an unlimited personal guarantee of the owner(s).

On larger, more complex working capital lines, the bank may do a line based on a percentage of the collateral’s value — known as a borrowing base. Collateral is normally the company’s assets, such as accounts receivable (A/R) and inventory.

With this LOC, you’ll need to understand the borrowing base calculation to know what your LOC limit is at any given time. For inventory, you might only be able to borrow 50% of its value (raw materials and finished goods), but for A/R, your bank may lend you up to 75% of its value.

CAP-EX lines are normally used for capital expenditures such as purchasing a piece of equipment. On Capital Expenditure lines, rather than monthly interest only due based on the balance, there is usually a monthly P&I payment due when there is a balance. The payment is typically based on the assets longevity, often 3-5 years. Unlike a working capital line of credit, a CAP-EX may not be on demand but require documentation in the form of an invoice for the equipment as well as possible down payment requirements. Each capital expenditure line is written uniquely. They are typically underwritten annually just like a working capital line and can save time by having the line in place, with no need to do full underwriting and creating loan documents each time a capital expenditure is made.

Tim Tumanic, President of J&R Machine, Inc. in Shawano is a big proponent of the CAP-EX line of credit.

“The manufacturing business can be difficult,” said Tim. “It’s very capital intensive. There’s a lot of competition out there, and you need to stay ahead with capital equipment. And do to that, you need a strong financial partner you can depend on. Tom Pennings introduced me to the CAP-EX line of credit, and it turned out to be the best product I ever could have been offered.”

View Tim’s testimonial video to learn more about J&R Machine, Inc. and what makes ICB a bank he can depend on.

Which LOC is Appropriate for Your Situation?

A working capital LOC is often used to meet routine operating expenses, like filling short-term liquidity needs, making seasonal inventory purchases or taking advantage of supplier discounts. Most small businesses occasionally find themselves in the situation in which a customer has delayed payment for some reason and, as a result, the company temporarily needs cash to cover payroll or make needed raw material purchases. If the company’s projections are solid and revenue is consistent, this is an ideal situation for a working capital LOC.

CAP-EX LOCs are optimal when an investment is needed to continue or improve operations. This could be as basic as needing to replace a fleet of vehicles or as impactful as continually needing to update and automate machinery.

If you’re unsure which LOC suits your situation better, the best way to proceed is by talking with your business banker. He or she can help you decide how quickly you intend to pay the expense off and whether or not you’ll have enough capacity on your LOC for other upcoming needs.

How a Bank Determines if You Qualify for a Line of Credit

The primary factors that determine your eligibility for an LOC are the maturity of your business, the capacity of your business to handle the repayment, collateral and how you intend to use the line.

  • The maturity of your business. Lenders look for a solid history of profitability and a record of consistent repayment as indications of creditworthiness.
  • Capacity limit. Using funds from your LOC shouldn’t put your business at risk; you should be easily able to repay the amount borrowed at any given time.
  • Collateral. The loan is secured by a first lien on business assets and, in most cases, on personal guarantees.

Every small business faces cash flow issues that could be temporarily improved using an LOC. If you’re looking to set one up, or want to discuss ways you can leverage your existing LOC to help you grow, reach out to one of Investors Community Bank’s small business experts.

Written by Tom Pennings

Tom Pennings is a Fox Valley native dedicated to customer-centric business banking. His well-rounded experience includes commercial deposits and lending, which contributes to his thorough understanding of the financial issues small business owners face. He enjoys frequent in-person visits with his customers and utilizing his network to connect people who can help each other's businesses grow.

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