Introduction
A line of credit can be one of the best financial tools for a business owner—when used strategically. It helps manage cash flow, fund growth, and avoid costly financial mistakes.
"A line of credit isn't cash flow, it's a tool. And like any tool, if you use it wrong, you might get hurt."
When managed poorly, however, it can create a cycle of debt that becomes difficult to escape. Let’s explore how to leverage a line of credit for stability and growth without creating cash flow nightmares.
What is a Line of Credit?
A line of credit is a revolving form of financing—you borrow what you need, pay it back, and borrow again. Unlike a traditional loan, interest is only charged on the amount used and is expected to be repaid in the short term.
"It is a short-term financing tool. This is not a long-term debt instrument."
Misusing a line of credit can lead to cash flow challenges, so it’s important to have a clear strategy before tapping into it.
When to Use a Line of Credit
A line of credit is best used for working capital needs such as:
- Delayed Accounts Receivable – When customer payments are delayed, but expenses need to be covered.
- Seasonal Fluctuations – Businesses with seasonal demand can use it to fund inventory ahead of peak seasons.
- Inventory Purchases – Ideal for purchasing stock ahead of a revenue surge.
- Marketing Initiatives – If a campaign is expected to generate a strong return, a line of credit can help fund the effort.
- Payroll (Temporarily) – While not recommended for ongoing payroll, it can bridge short-term cash flow gaps.
"A line of credit can be a phenomenal tool, particularly as you move through selling season in November and December."
When NOT to Use a Line of Credit
Certain situations make a line of credit too risky:
- Paying Off Other Debt – This can create a dangerous debt spiral.
- Long-Term Investments – Lines of credit are short-term tools and shouldn’t be used for long-term obligations.
- Lack of Repayment Plan – Borrowing without a clear way to pay it back can lead to financial trouble.
- Unnecessary Cash Cushion – Using a line of credit just because it’s available isn’t always wise.
"If you're trying to use a line of credit to buy time and you don't have a clear repayment plan, it's probably not a wise decision."
Managing a Line of Credit Like a CFO
To use a line of credit responsibly, follow these best practices:
Have a Repayment Plan
Before borrowing, determine how you will repay the amount.
"If you're going to pull out $100,000, where is that $100,000 going to come from in order for you to pay it back in the short term?"
Limit Usage to 50-60% of Available Credit
Keep borrowing below 60% of the credit limit unless absolutely necessary to maintain flexibility.
Keep the Line Open, Even If Not in Use
Maintaining a line of credit ensures access to capital when needed and makes renewal easier.
"It's easier to renew your line of credit when it's already in place than to stand up a completely new one."
Negotiate Terms Upfront
Secure favorable terms, including:
- Interest rates
- Repayment flexibility
- Draw fees
- Collateral requirements
"If you negotiate terms upfront, like your interest rates, your repayment flexibility, your fees, that will help you to get better terms."
Monitor Cash Flow and Debt Ratios
Regularly review financial statements to ensure you’re not over-leveraging.
"You want to continually be looking at your current or quick ratio—your current assets on hand relative to your current liabilities."
Key Terms to Review in a Line of Credit Agreement
Before signing a line of credit agreement, pay attention to:
- Interest Rates – Fixed vs. variable rates.
- Collateral Requirements – Understand what secures the line.
- Repayment Terms – Is it revolving or fixed?
- Bank Covenants – Are there liquidity or reporting requirements?
"Be thinking about the ancillary impact of signing these types of contracts that could have a ripple effect on your responsibilities moving forward."
Final Thoughts
If you already have a line of credit, evaluate whether you’re using it strategically. If not, consider setting one up while your business is financially strong.
"If your business is in a financially strong position, you will get better terms on a line of credit, and it is always helpful to have it as a backstop."
Action Item: Review Your Line of Credit Agreement
- Check for hidden fees and restrictions.
- Renegotiate terms if needed.
- Discuss with your banker to ensure your line of credit aligns with your growth strategy.
By using a line of credit wisely, businesses can improve cash flow management, fuel growth, and build financial resilience for the future.
