Line of credit (LOC) loan is a valuable financing tool for business enterprises to meet their day-to-day working capital needs as well as fulfill other financial obligations. Line of credit (which is like loan on line) is a facility that allows businesses to apply and qualify for borrowed capital without much hassle. It is one of the simplest ways to fuel business growth and fund other revenue-generating projects.
Most lending institutions look for at least a few years of the business’ payment history prior to sanctioning a LOC finance. If eligible, lenders provide you with a fixed amount of line credit, you can utilise as per your requirement for transitory business needs. The process of availing these loans is now much easier with the recent emergence of a number of fintech platforms.
1) What Is Line of Credit Loan?
2) How Does a Business Line of Credit Work?
4) Advantages of Line of Credit
5) How is Repayment Done in Line of Credit Loans?
Before opting for a business line of credit loan, here’s comprehensive guide on line credit and the different types of LOCs to make an informed decision.
Line of credit is a flexible loan facility, wherein lending institutions offer a defined limit of credit that one can access as per his/her requirements. Borrowers can either repay the used amount immediately or over a predetermined tenure. For the latter, the interest accrues on the used credit on a day-to-day basis. Also, borrowers must be careful of not exceeding the amount of credit limit set in the agreement and make timely repayments to avoid excessive interest.
LOC loans are low-risk revenue sources defined by the following features:
So, while traditional loans are preferable in the case of a lump sum requirement, LOCs are suitable to meet short-term financial requirements due to their flexibility.
Financial institutions, while institutions while extending a business line of credit, first evaluate the business’s market value, profitability, and market risk before determining the maximum credit value. Depending on the requirement, businesses can seek unsecured or secured LOCs.
A business line of credit works differently than a term loan. In case of a term loan, borrowers receive one-time lump sum credit that they need to repay over a pre-set repayment tenure. Whereas, with a business line of credit, borrowers can continue using and paying back credit as long as they don’t exceed the credit limit.
Hence, if you are a business owner aiming for expansion or are unable to ensure smooth business operations due to a working capital limitation, a business line of credit can be of immense help. With such a facility, one can use the allotted credit as per custom requirement and accomplish funding needs like:
Lines of credits are broadly classified into secured and unsecured types.
Most LOCs are unsecured as a borrower does not have to pledge any collateral to back it. Such credit products usually have a lower credit limit and a high interest rate. It is a suitable funding option for individuals unable to meet short-term financial requirements.
In this case, borrowers receive funds from a lending institution against collateral. Secured LOCs are attractive working capital sources for businesses. These come with a higher limit and significantly lower interest rates.
Some examples of line of credit loans are:
A Line of Credit (LOC) offers several advantages or benefits, particularly for businesses looking for flexible financing options. Here are some key benefits:
A LOC allows businesses to draw funds as needed, up to a certain limit. This is especially useful for covering short-term cash flow gaps, financing specific projects, or managing seasonal fluctuations in revenue and expenses.
Unlike a term loan, where you receive a lump sum upfront, a LOC allows you to borrow exactly what you need, when you need it. This can lead to lower overall borrowing costs since you only pay interest on the amount you use.
h3>>Revolving CreditLOCs are typically revolving, which means that as you repay the borrowed amount, the credit becomes available again for use. This revolving nature provides ongoing access to funds without the need to reapply for a new loan.
LOCs often have lower interest rates compared to credit cards, making them a more cost-effective option for financing. The interest is usually only charged on the amount drawn, not the entire credit limit.
Once the LOC is set up, accessing the funds is usually straightforward and quick, often through a simple bank transfer. This can be crucial for businesses that need to respond rapidly to market opportunities or unexpected expenses.
By providing a cushion for cash flow, a LOC helps businesses manage their finances more effectively. It can bridge the gap between receivables and payables, ensuring smooth operations.
Responsible use of a LOC, including timely repayments, can help a business build or improve its credit rating, which can be beneficial for future financial endeavors.
Some LOCs are unsecured, meaning they do not require collateral. This can be advantageous for businesses that do not have significant assets to offer as security.
With a LOC, businesses can plan ahead, knowing they have a financial safety net. This can aid in more accurate budgeting and financial forecasting.
It can act as a financial safety net for unexpected expenses, providing peace of mind for business owners.
Interest on a LOC used for business purposes is often tax-deductible, though it's important to consult with a tax professional regarding specific circumstances.
However, it's important to use a Line of Credit wisely and understand the terms, including interest rates and repayment schedules, to avoid potential financial pitfalls.
Most lending institutions allow borrowers to repay the withdrawn funds early so that they accrue less interest. Borrowers can also request or qualify for a certain limit, but they do not have to utilise it completely. One can tailor his/her LOC’s use as per the requirement, thereby paying interest on the amount withdrawn until repayment.
The borrower is not mandated to repay the balance within a particular date, unlike term loans. Borrowers can thus either repay the outstanding balance all at once or in the form of minimum monthly payments. However, one must pay the interest accrued within the pre-set date.
If you make repayments during the withdrawal period, a portion of the repaid amount will go towards the interest component while the other portion would represent the principal and will be added back to the credit line.
Borrowers can also opt for invoice discounting services, wherein the lending institution provides funds against a certain percentage of the unpaid invoices.
KredX offers invoice discounting service to businesses though a simple on-boarding process, following which you can receive funds against unpaid invoices within 24-72 hours*. This hassle-free digital lending is entirely transparent and provides you with healthy cash flow as per the value of your invoices.
The following section discusses the differences between a business line of credit and invoice discounting services.
An example of a "Line of Credit" (LOC) can be illustrated through a fictional scenario involving a small business:
ABC Tech Solutions, a small IT services company, recently opted for a 'line of credit loan' to manage its varying cash flow needs. This flexible 'loan on line' allowed them to access up to $50,000 whenever required. When they needed $15,000 for a project, they simply drew it from their 'line of credit.' Interest was charged only on the $15,000 used, not the entire credit line. This 'line credit' solution provided them with the financial flexibility to meet immediate expenses without the burden of a traditional loan.
Here’s the comparison between the concept of line of credit and bill discounting -
Borrowers must satisfy a set of stringent eligibility criteria to avail a line of credit. And, in some cases, such as under a secured business line of credit, they need to pledge a valuable company asset as collateral. Contrarily, the eligibility criteria for bill discounting are less stringent, and you can gain access to the necessary working capital instantly. KredX, a leading provider of bill discounting services, sanctions cash advances against unpaid invoices within 24-72 hours*.
In the case of line of credit, the credit limit is determined by several factors like one’s requirement of cash advances, available cash flow, and assets.On the other hand, invoice discounting depends on the amount of receivable accounts from a business’s creditworthy clients and its ability to collect the debts.
It is rather difficult to maintain a strict credit line as most LOCs are associated with specific covenants or rules that a business must comply with to keep the credit line in place.As opposed to a line of credit, KredX does not possess such covenants with loans sanctioned against unpaid invoices. All a business needs to do is collect timely payments from the clients against the raised invoices.
With LOCs as a business’s cash flow and assets must justify the credit line extension. However, with invoice discounting it is relatively easier to increase the credit line. One needs to provide information to the lending institution regarding his/her business’s anticipated customers and expected volume to avail financing. Your chances of increasing the credit line are significant as long as your account is in good standing.
Understanding the nuances and practical applications of line of Credit (LOC) loans is crucial for any business looking to effectively manage its financial needs. The examples and insights provided in this blog illuminate how LOCs offer a flexible and accessible financial solution, particularly for managing working capital and addressing short-term financial obligations. By opting for an LOC, businesses can navigate cash flow challenges with greater ease and adaptability. Additionally, for those seeking an even more streamlined and transparent financing option, KredX’s invoice discounting solutions present a viable and efficient alternative. With these financial tools at your disposal, ensuring the smooth operation and growth of your business becomes a more attainable goal. Remember, the right financial strategy, whether it's an LOC or invoice discounting, can significantly contribute to the sustainability and success of your enterprise.
A line of credit is a flexible loan from a bank or financial institution. Similar to a credit card, it gives the borrower a maximum loan amount, and they can access funds as needed. Interest is only paid on the amount used, not the total credit available.
In banking, LOC stands for Line of Credit. It is a type of credit facility provided to a borrower, allowing them to draw funds up to a predetermined limit as needed.
A credit line system is the the arrangement between a financial institution and a borrower where the borrower is allowed to borrow up to a certain limitwith interest charged only on the borrowed amount.
An LC line of creditis a financial instrument used mainly in international trade. It is a guarantee by a bank on behalf of the buyer (importer) to the seller (exporter) that payment will be made on time and for the correct amount. It differs from a traditional line of credit as it is specific to a single transaction.
An example of a line of credit is a business obtaining a $100,000 LOC from a bank. The business can draw funds up to this limit to cover various expenses like inventory purchase, payroll, etc., and pays interest only on the amount used. For instance, if they use $20,000, they only pay interest on that amount, not the entire $100,000.
A loan gives the borrower a lump sum of money upfront, which is then repaid over time with interest. A line of credit, on the other hand, offers a credit limit that the borrower can draw from as needed, paying interest only on the amount used. Loans are typically used for one-time expenses, while lines of credit are suited for ongoing or variable expenses.