More
than 90% of small-business owners are worried about experiencing an
economic recession over the next 12 months, according to a June 2022
Goldman Sachs survey.
Because
lenders tend to tighten their lending standards during recessions,
small-business owners may be looking for ways to secure funds before
access to credit is possibly reduced.
One
option to consider is to apply for a business line of credit — even if
you don’t need it right now. Unlike a business loan, a line of credit
lets you decide when to withdraw funds and how much to take out, up to a
set limit.
WOULD YOUR BUSINESS BENEFIT FROM A LINE OF CREDIT?
Since
it’s common for access to financing to decrease during a recession,
getting a line of credit before you need it can be a smart move,
especially if you see the potential for cash flow issues in the future.
For
example, if you plan to make large investments in inventory and
materials or take on projects that require substantial outlays of cash
before you receive payment from your customers, a line of credit can
help ensure you have funds available in the future to do it.
In
addition, a line of credit can be used to cover operating expenses such
as rent, wages, insurance and maintenance when your business
experiences a short-term reduction in revenue.
Generally,
lines of credit are a good option for businesses that are concerned
about fluctuating needs for funds, according to Carolyn Katz, a mentor
at the New York City chapter of SCORE , a nonprofit organization
offering education and mentorship to small businesses.
When
you decide to apply for a credit line, “you should try to get whatever
line is available to you,” says Katz, “because even if it doesn’t fully
cover your costs, drawing it down and repaying it regularly will help
you earn your way to a larger line.“
ARE THERE DRAWBACKS TO HAVING A CREDIT LINE?
If
fluctuating cash flow isn’t a concern, your decision to apply for a
line of credit is more complicated. While a line of credit could be used
as a reserve or emergency fund during challenging economic times, there
are drawbacks to consider when getting one that may not be used.
It
takes time to apply and complete the necessary paperwork, the lender
may charge a maintenance fee if you don’t use the line and your limit
may be lower than you want. Also, because lenders look at credit lines,
even unused ones, when evaluating a borrower, a line of credit could
negatively affect your ability to get other types of financing.
WHAT DO YOU NEED TO GET A LINE OF CREDIT?
If
the benefits of a line of credit are stronger than the drawbacks for
your business, and you decide to apply for one, lenders will typically
review your business profitability,
credit score
and accounts receivable. Accounts receivable, the money owed by
customers for goods or services, represents future revenue that can be
used to pay off your line of credit.
“Receivables
are important for any kind of a loan product, but in lines of credit,
your accounts receivables are really the No. 1 criteria,” Katz says.
Also, keep in mind that
older accounts receivable
can be considered at risk of nonpayment. Katz says, “if a line of
credit is something that you’re going to be looking at, try to keep your
receivables below 60 days.”
WHEN SHOULD YOU APPLY FOR A LINE OF CREDIT?
Shauna
Huntington, from the NAWBO Institute of Entrepreneurial Development,
the non-profit education foundation of the National Association of Women
Business Owners , says that business owners who want a line of credit
should consider getting it before they actually need it.
“If
they wait until they get that large order and they need the line of
credit to produce it, it’s going to be harder to go to the bank and ask
for that money at that time and get it turned around quickly,”
Huntington says.
With
the option to draw down money as needed, a business line of credit can
be the right move for businesses that are concerned about cash flow
issues in the future. However, a line of credit, used solely as a way to
hedge your bets on an uncertain economy, may be an unnecessary expense
that offers few, if any, benefits.