A working capital line of credit is a flexible lending instrument usually secured by the assets of your business.
Typically, working capital lines of credit are designed to meet the short-term cash flow needs of a business and are issued for a one-year term with annual review and renewal. Interest-only payments are required initially, with principal due at maturity.
For the small businessperson, the two main causes of cash flow shortfalls are financing inventory and accounts receivable. In today’s business climate, it is unfortunate but true that the better the quality of your accounts receivable, the slower they are to pay, placing a strain on your cash flow because, in effect, you are now providing interest-free financing to your customer.
A true working capital line will have fluctuations in the balance on a daily or monthly basis. For example, one month you might purchase inventory requiring additional cash to fund and store the purchase. During the normal cycle of business, when this inventory has been sold and converted to cash, you would pay down on the line of credit.
Heavy borrowings under your working capital line can be traced directly to your business cycle.
One simple way to assist your cash flow is to match as closely as possible your accounts receivable and accounts payable. If your accounts payable give you 30 days to pay and you know it will take your accounts receivable 30 days to convert to cash, don’t pay your accounts payable as soon as you receive them, causing a cash flow shortage.
Take advantage of the payment terms your creditor is providing and conserve your cash until you get paid from accounts owed to you.
Working capital lines of credit can be structured several different ways. An experienced relationship manager who understands your business cycle can structure your line based on your needs. Depending on the situation, a line of credit can be secured with other assets as well.
For a company that might need to purchase multiple vehicles during the year, an equipment line of credit, which would be termed over at maturity, might be in order. This type of line saves you from having to apply for each loan individually, write multiple checks for payment and carry several smaller loans on your books.
An equity line of credit secured by the equity in your commercial building is another option. This allows you to tap into the equity in your building to finance your company’s working capital needs.
When discussing lines of credit, ask your banker lots of questions. A clear understanding of what your needs are can make a world of difference. And be open to suggestions from your banking partner as far as options for structuring a line of credit.
Here are several common structural items for lines of credit:
* Formula based. For growing companies, sometimes a larger line to grow into is appropriate.
Accomplish this by attaching a formula tied to the age of accounts receivable and inventory to the credit line and reporting this to the bank each month. For example, even though you have a $500,000 working capital line of credit, availability is subject to a calculation of 80 percent of accounts receivable less than 60 days old plus 50 percent of inventory equals availability under your line.
* Longer term. Despite the fact that most working capital lines of credit are on one-year terms, your bank can set the term for a longer period. However, it may want to place some meaningful financial performance covenants in place with annual increases to do so.
* Personal guaranty. As a small business owner, you will in all likelihood be asked to personally guaranty the loans to your business. By doing this, you are telling your bank that as its business partner, you will stand behind the business and conduct all business operations in a fiscally responsible manner. Dan Flynn is a commercial lender with The Grange Bank. He is located at the firm’s South Front Street main location in Columbus. Reach him at (614) 449-5338 or via e-mail at [email protected]