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Using Business Lines of Credit Responsibly: A Guide for Owners

Getting a business line of credit can be a great way for small business owners to access working capital when they need it. However, lines of credit come with responsibility – if not managed properly, they can lead a business into dangerous debt levels. As a business owner, it’s important to understand best practices for using your line of credit responsibly.

What is a Business Line of Credit?

A business line of credit works similarly to a credit card. Your bank provides you access to a set borrowing limit, and you can draw down funds up to that limit as needed. As you repay the balance, that amount becomes available to access again.

Lines of credit typically have variable interest rates, so your monthly payments will fluctuate depending on the market. There are also usually no set repayment schedules – you pay interest monthly on your outstanding balance, and can pay down principal as much as you want each month.

Benefits of Using a Line of Credit

There are a few key reasons a line of credit can be helpful for small businesses:

  • Access capital when you need it – With a line of credit, you can draw down funds any time an unexpected expense comes up or you have a short-term cash flow gap. You don’t need to apply and wait for financing each time.
  • Flexibility – Since there are no set monthly principal payments, you can tailor repayments to align with your business’ cash flow availability each month.
  • Potentially lower rates – Line of credit rates are often more favorable than other financing options like merchant cash advances or short-term loans.

Dangers of Irresponsible Use

However, lines of credit do come with risks, especially if used irresponsibly:

  • Difficulty paying back – If you overextend and draw down too much, the monthly interest and principal payments could become unaffordable.
  • High interest costs – The longer you take to pay back your balance, the more interest you accrue. Rates are variable, so they could rise over time as well.
  • Hurts cash flow – If repayment takes away money needed for other business expenses, it can negatively impact operations.
  • Damage business relationships – Like personal credit, maxing out a line of credit or missing payments hurts your business credit score and eligibility for future financing.

Best Practices for Responsible Use

The key is using moderation and carefully planning your withdrawals and repayments. Here are some tips:

  • Set a reasonable credit limit – Don’t take on more borrowing capacity than you know your business can afford to pay back in a reasonable timeframe. Build in buffer room.
  • Have a plan for use – Outline ahead of time how much you plan to withdraw and what the funds will be used for. Tracking this can help avoid unnecessary spending.
  • Withdraw only as needed – Don’t tap the full credit line without good reason. Only take what you need for the short-term uses you outlined.
  • Make interest payments each month – Set calendar reminders for yourself to make monthly interest payments on time. This prevents balance growth.
  • Pay down principal when possible – When cash flow allows, make principal paydowns to ensure you’re moving in the right paydown direction.
  • Avoid maxing out – Never tap the full limit. Maintain at least 10-20% as an unused buffer so you have room if an emergency comes up.
  • Have an repayment plan – Know how long you expect it will take to fully pay back balances withdrawn and stick to that timeline.

What to Do if You’ve Overextended

If you do accidentally overextend your business line of credit, don’t panic. Here are some smart money management tactics:

  • Reduce spending – Trim expenses wherever possible, even temporarily, to free up more cash for accelerated debt repayment.
  • Consider balance transfer – Some banks offer introductory 0% balance transfer options. This reduces interest costs as you pay down principal.
  • Talk to your lender – Explain the situation openly and see if they can offer modified repayment terms to make it more affordable.
  • Explore refinancing – You may find a better rate or more favorable structure with another form of financing like a small business loan.
  • Use earnings wisely – Put any windfalls, seasonal upticks in revenue, or side income directly toward credit line paydowns.

With the right diligence and restraint, a business line of credit can be an invaluable source of accessible working capital financing. Maintain responsible spending and payment habits so it works for you rather than against you. Monitor your balance and cash flow closely each month to ensure you stay firmly in control.

Resources

For more tips on using credit wisely, check out these articles:

There are also some helpful videos on YouTube:

And don’t forget to tap into free small business advising resources like SCORE.org for personalized debt and cash flow advice.

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