Line Of Credits

Why aren’t all loans line of credits?

The concept of a line of credit is easy to understand. A company borrows money from a bank as they need the funds for operations and other purposes. For companies in many industries these loans allow for flexibility to borrow as the need arises and to repay amounts as needed.

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There are several weakness to line of credit arrangements however. For one the line of credit typically charges an amount for balances that are not lent out as a fee for reserving these funds. This can be challenging for a small business to understand and accept. Further, having an open ended loan agreement can sometimes lead management to use these funds as needed and as a crutch never developing the discipline that structured loan repayment terms offer. If you know that you have to repay an amount then it is easier to devote money to that need. But if your loan is open ended like a line of credit it is harder to do so.

Finally, a line of credit agreement can sometimes not be sufficient for large purchases a small business makes for land or building purchases and a business may need to get funding elsewhere.

Line of credit agreements make sense for some businesses but they are not for everyone. Consider the pluses and minuses of these loans to see if they are right for your small business.