Lines of credit…just in case

Whether your business is a start-up venture or an established corporation with a seasoned customer base, there is one thing no owner can do without: cash flow. A business will sink fast if it can’t pay employees, rent and bills. Short-term capital is crucial to fund the operating costs so a company can deliver its products and services to customers.

Of course, pedaling through the cycle of selling, producing, delivering and collecting would be easier if the economy was always stable and customers always paid on time. But since this is not the case and there are always different internal and external variables that affect cash flow, business owners need some security. Short-term lines of credit can help organizations stretch through lean times, says Craig Johnson, president of Franklin Bank, Southfield, Mich.

“Whether or not you have immediate need for a line of credit, it is a good safety net to have in place,” he says.

Because no business faces the same financial and growth issues, discussing options for various lines of credit with a banker will ensure that you seek the right type of loan, Johnson tells Smart Business. Even if you don’t need the credit line immediately, having a “Plan B” in case of cash emergency is always a good idea.

How should business owners use a short-term line of credit?

Companies need working capital lines of credit to support the timing difference between the receipt of payment from customers and the bills that are due for employee wages, rent and general operating costs. But keep in mind that the purpose of a line is not for long-term financing. You should not use your line of credit for capital improvements or expenditures.

What qualifications do banks review when evaluating a business for a line of credit?

From a banker’s standpoint, we want to see that the business has a track record — that receivables historically are paid on a timely basis, the receivables base is diverse, and if they have a line of credit that they’ve used it properly. That means they have made positive movement on the line of credit, so when they receive payments, they use that money to pay off the line of credit.

Are there exceptions?

The numbers are certainly important, but if you have trust in the management of a business, that goes a long way. Say a business owner wants a line of credit, but the company lost $1 million the year before. If the owner is not doing anything fundamentally different to change the company’s financial position, he or she will not get approved. But if the owner has a plan, has made appropriate budgetary cuts, and if we believe in the plan, we will take all of this into consideration.

What about growing businesses that rely heavily on credit?

In growth companies, lines of credit often become permanent working capital. Owners draw to the max, and because they continue to grow, they are never able to pay down the credit line before they work it back up. In this case, sit down with your banker and term [the credit] out over a period of time. Then, you might get another line and use that to fund short-term expenses.

What if a customer does not qualify for a traditional line of credit from a bank?

Say you are a growth company that has outstripped your capital, and a bank is not willing to extend additional capital until your earnings and balance sheet catch up with you. A factor is a good alternative. A factor buys/owns your accounts receivables, providing you cash to finance necessary payroll and operating expenses.

If you are a mid-size business and you’ve worked through financial difficulties, try a bank with a good asset-based lending group. It may extend a line of credit but set more controls. And that is not a bad thing. This type of financing can be more expensive, but it is a solution for companies that can’t secure traditional lines of credit because of fast growth or a less established business history.

Small businesses should look into an SBA Express Line of Credit. This program gives bankers a level of comfort if a business is a start-up or does not have an established history.

Finally, you can get unsecured lines of credit, and these are for established businesses with long track records of successful performance and strong balance sheets. Most working capital lines are secured by accounts receivables, equipment and personal guarantees from the principals. But unsecured loans do not require collateral as a secondary payment source should an owner default on the loan. A bank must consider you a low risk before it will approve this type of loan.

CRAIG JOHNSON is president and CEO of Franklin Bank. Reach him at (248) 386-9860 or [email protected].