Business Line of Credit: Answering all your questions

For a small business owner, it can be a challenge to arrange a fresh source of funds to meet operational requirements and to fuel growth. In such situations, a business line of credit comes in handy; as it can help you meet monetary requirements and provide much-needed financial flexibility.

Since a business line of credit is revolving credit, it is different from normal credit facilities. It can be complex and difficult to comprehend for someone who is not familiar with loan products.

Here are some commonly asked questions about business lines of credit that will help you understand this financial product and assess its benefits.

What is a business line of credit?

A business line of credit (LOC) is a type of revolving credit (similar to credit cards), which is ideal for small businesses.

Under this facility, businesses receive a pre-approved amount of credit, which can be used as and when required. An LOC is suitable to meet short-term working capital requirements and must be repaid as per the terms of the loan. The interest rate is charged as soon the money is borrowed but only on the amount borrowed.

In short, a business line of credit allows businesses to borrow the fixed amount (in parts or whole) when required, repay and use it again.

Is a business line of credit different from a business loan?

Yes, a business line of credit is completely different from a business loan. A business LOC provides a fixed amount of money, which can be used when needed. On the other hand, a business loan provides you with a lump sum amount to meet specific business requirements.

Here are some other factors that differentiate them. 

Interest rate: The interest rate levied on a business LOC is variable in nature and is tied to a specific benchmark lending rate plus premium. There are higher chances of monthly fluctuations in the interest rate.

Whereas, the interest rate on a business loan is predetermined and is constant for the whole duration of the loan.

Loan repayment tenure: A business LOC has flexible loan repayment tenure and needs to be repaid in the form of EMIs within a defined time frame. The EMI amount can vary every month and depends on the amount drawn in the previous 30 days. 

In contrast, a business loan comes with fixed loan tenure, predetermined payment schedule and set repayment amount. 

Fees: A business LOC carries initial processing charge and charges associated with each withdrawal. In addition, the enterprise is charged with an annual percentage fee on the unused line of credit. 

In business loans, there is a processing fee, administration fee and appraisal fee for any collateral. Other charges include prepayment penalty, legal fees, and late payment fees among others.

When should I apply for a business line of credit?

As a small business owner, you should consider taking a business LOC if you are in constant need of funds to meet your short-term obligations.

For example, if you run a seasonal business where cash flow is irregular, then you can apply for a business LOC to fulfill the business requirements during the off-season. If you need to ensure timely payments to vendors to maintain the supply chain, then a business LOC is very useful. 

Secondly, you should have an established business credit profile and personal credit profile to be eligible to apply for a business LOC. Your business should also have an established revenue record to be eligible for a business line of credit.

How do I apply for a business line of credit?

Applying for a business line of credit is similar to applying for a business loan. Here are the steps you need to follow to apply for a business line of credit:

1. Review the credit score and financial performance of your business, as they are a major criteria for the approval of a business LOC application
2. Compare different lending options to know how well you qualify for various loan products
3. Check the eligibility criteria with different lenders
4. Compare the costs and other fees applicable to a business LOC facility with different lenders
5. Once you have finalised the lender, fill the application form and submit it along with the necessary documents

Is collateral required?

There are two types of business LOC – Secured LOC and Unsecured LOC.

A secured LOC requires collateral in the form of property mortgage, fixed deposits, life insurance policies etc. Whereas, in unsecured LOCs, the lender relies on the financial and credit history of the business and borrower to extend a business LOC facility. 

Am I eligible to apply for a business line of credit?

The eligibility criteria to apply for a business LOC variess from lender to lender. However, the primary eligibility criteria to apply for a business LOC are:

1. A good credit score of both the business and borrower
2. A stable financial history with profitable business operations
3. The business should be in operation for more than 3 months
4. The business should be legal in the eyes of the law 
5. The enterprise should not be a Trust, NGO, charitable institution or excluded from the list of eligible entities

Which documents are required to apply for a business line of credit?

Some of the common documents needed to apply for a business line of credit are:

1. Proof of business registration certificate (Partnership Deed, Certificate of Incorporation/ Article and Memorandum of Association, Trade license, GST registration certificate)
2. Proprietor's PAN Card, AADHAR Card, and valid address proof ( in case of a partnership, all partners should provide their identity proof)
3. Last 12 months business bank statement
4. Tax returns
5. Business financial statements including P&L statement, cash flow statement, balance sheet etc.

What happens after I apply for a business line of credit?

After applying for a business LOC, the lender scrutinises the application and determines the credit line amount, interest rate, and terms based on the business financials and credit profile.

The terms include minimum payment due each month, annual charges and fees, late fees, tenure of repayment etc.

Following the evaluation and finalisation of the terms of the business LOC, sign the documents as required by the lender. The funds will be made available to your account, which can be accessed via online bank transfer or cheque. 

How much interest will I have to pay?

The interest rates are based on your business's credit profile, soundness of financial statements and repayment capacity. Generally, the rates are comparatively lower than traditional unsecured sources of finance.

The interest rate on a business line of credit generally ranges from 10 per cent to 15 per cent annually.

How do I request an increase in credit line?

Before requesting an increase in the credit line, ensure that you have a favourable history of repayments and credit line utilisation. Here are some tips to increase your business line of credit:

1. Have justifiable reasons before placing a request for an increase, like higher order volume or large contracts
2. Have up to date financials to show tight cash positions. The business needs to show viability and strong fundamentals through financials and business history
3. Consider offering additional collateral to get a higher line of credit and lower the risk financial institutions take when they extend higher limits on the credit line

There is a diverse range of requirements that every entrepreneur needs to fulfill to run a business operation successfully. To accomplish this, the business needs to have financial flexibility without which it can lose the competitive edge. 

A business line of credit helps businesses achieve the desired growth, provides the required flexibility and facilitates smooth operation. A business line of credit is the best way to meet short-term capital requirements and fund other initiatives towards the expansion of your business.