Fifth Third Bank talks about lines of credit

How can you maintain the quality of your short-term assets to increase borrowing capacity?
You need to make sure both your accounts receivable and inventory are of high quality, since the lines of credit are typically secured by these accounts. That means monitoring accounts receivable to make sure they are under 90 days from invoice date.
Inventory should also be current, with quick-turning products that are not obsolete in the marketplace. Letting the receivables or inventory go stale may cause the lender to exclude these assets from the collateral base, which would reduce the amount you can borrow.
Having a collections person or department is usually a sound investment in order to maximize the amount you can borrow under the line of credit. This makes sure you collect your money in a timely manner and are paid for the product or service you have already provided.
What are the different forms of short-term lines of credit?
A seasonal line of credit may be appropriate for companies with highly fluctuating sales and collection periods. For example, a retailer that records the majority of sales during the holiday season may only need access to the line of credit in the middle of the year when inventory is building in preparation for the fourth quarter sales period.
Once the heavy collection period ends by mid-January, the company will use cash to pay off the line of credit and fund operations until mid-year.
These lines of credit will typically have a cleanup period required by the bank, during which the line of credit balance is required to be zero for several months. This is a good indicator to the bank that you are properly managing the cash collection cycle and utilizing the short-term line of credit to fund short-term cash needs only.
How can you ensure you are using your credit line properly?
This is critical for a growing business. If sales are growing, accounts receivable should be growing, as well. As you sell more products, you need to replenish supplies to build inventory.
Buying supplies and paying employees takes cash, which you may not have until after you collect on your receivables. This typically will not happen for 45 days or more, so you may have to cover the costs of your employees, overhead, interest expense and other areas before you collect from your customers.
Using a line of credit to cover these expenses can be one of the uses of a short-term line of credit. The line of credit then gets paid down once receivables are collected, and the cycle starts all over again. Your lender will be watching to make sure the line of credit balance moves up and down in conjunction with your collection cycle.
If it doesn’t, that may indicate to the bank that the short-term line of credit is being used to fund operating losses. This may be a sign of weakness in the underlying business and could cause concerns for the lender.
William W. Carroll is a vice president with Fifth Third Bank. Reach him at (513) 534-4788 or [email protected].