Does your business need a line of credit? How about a loan? It’s important to know how and when to use each in order to optimize your borrowing, and the first step is understanding how your bank views your business and your need for loans and/or lines of credit.
Your bank is basically a low-risk investor in your business. They really don’t want to own a piece of your business, and they certainly don’t want to own any of your business assets (what they call collateral). When they loan your business money, their only priorities are getting their money back and making whatever rate of interest they deem appropriate. You may have looked at loans and lines of credit as an interchangeable means of meeting your cash needs, but your bank does not.
First, let’s consider lines of credit. For lines of credit, banks usually accept Cash or Receivables as collateral. Their expectation is that these funds are used for short-term needs, such as purchasing inventory that will be turned quickly into sales. That is why lines of credit are typically issued for the short-term, or at best annually. The bank expects these funds to be repaid quickly, so this method of borrowing should be used when you need quick funds and expect to use those funds to generate revenue quickly. You may pay an origination fee to secure a line of credit, but you will not pay interest until you actually borrow against the line of credit.
Next, let’s consider loans. In exchange for a loan, banks usually expect title to a piece of equipment or other long-lived asset as collateral. They understand that these funds will be used to purchase an asset that will generate income over a period of time, and they are willing to extend longer repayment terms, as long as the collateral they hold covers the risk of default. This method of borrowing should be used for the purchase (or upgrade) of long-lived assets. The interest rates for loans may be lower than the rates on lines of credit; however, interest is paid over the entire term of the loan.
When it is time for a line of credit or a loan, now you will be able meet with your banker knowing which financing method is most appropriate for your situation and have a better understanding of what the transaction means for your bank.
When you approach your bank for a line of credit or loan, remember that the bank is looking at the transaction as a low-risk investment in your business, so they are interested in more than your ability to meet your day-to-day operating and debt service obligations. Certainly, they are interested in seeing a solid past performance, but their ultimate goal is recouping their investment in your business, so they will also expect you to provide a well-defined plan that supports your future financial viability and their repayment terms. To successfully secure either type of financing, you will need to present your information in a way that captures and articulates your expected future performance.
Visit our website (www.tbsi.consulting), then give us a call at 866-960-0428, Ext 702, if we can help you develop more useful, more meaningful information to grow, groom or get the most out of your business.