A working capital line of credit is essentially a revolving line of credit from which your business can draw from and pay back as needed.
Example: Your small business just closed a larger then average customer. However, your business needs to pick up $10,000 in materials to complete this new, very profitable job.
However, your cash situation is a little low given the recent slow recovery we all are facing.
You had a business line of credit years ago, but the bank that held that line was one of the many that had to take the government’s TARP funds and thus, to improve its own balance sheet, reduced your line of credit to your last outstanding balance of $2,000. After which, you did not renew the line (and pay the hefty fee for it) and thus, your line of credit expired.
So, what are you going to do now? You don’t think your bank or any of the local banks will provide you another line of credit – not for the $10,000 you are seeking.
Most of the banks that remain are struggling themselves – and are unlikely to take your call. Plus, it probably would take them months before you got an approval or decline – time that your business just does not have right now.
A simple solution is a business credit card.
A business credit card is essentially a working capital line of credit. It is designed for short-term purchases and financing. Just like the example above.
The only real differences between a business credit card and a traditional business line credit are:
1) A traditional line of credit typically has to be zeroed out – once a month, once a quarter or at least once a year. This means you have to pay your balance to zero a least once during the term of the line.
The reason is that the banks force you to properly use these lines of credit for the purpose they were designed for – short-term and short-term working capital only.
Business credit cards do not have that restriction. You can draw from the line and pay it back when it best fits you to do so as long as you stay within your credit limit.
2) Traditional lines of credit can potentially have a much larger credit limit. Good if you need it – but, if you only need a little to get by – like our example above – a business credit card’s limit will more than meet your working capital needs.
Other benefits of business credit cards:
- Easy and quick to obtain. You can get an approval in minutes as compared to weeks and months with a traditional line of credit.
- You can easily use your business credit cards to pay for online purchases or to make quick buying decisions when talking to your suppliers – Or, make purchases that are sometimes restricted by your line of credit; like paying your phone or internet bill.
- You can give cards to your employees – with restrictions on the amount they can spend and where those purchases can be made.
- Business credit cards are typically unsecured – requiring no business collateral or financial assets tied to the line like with accounts receivable lines of credit.
The real con to using business credit cards when compared to traditional business lines of credit is the interest rate.
Example: You business line of credit may have an 8½ percentage interest rate. Your business credit cards might have a 12 percent rate.
But, if you use your business credit card like you should – meaning for short-term working capital – then the rate should not really matter all that much.
Let say you will use the $10,000 business credit card to purchase supplies and after the job is done in two months – you will repay the $10,000 – the way you should use any working capital loan. If you held that balance outstanding for two months, your net costs (your interest costs) would be $150 at 12%. Whereas if your business used a traditional line of credit with an interest rate of only 8% - your net costs would only be $100 – that is if you could get a traditional business line of credit soon enough to make the delivery to your customer.
Now, 50 dollars is 50 dollars – but, compare that to either making the profit on the job by using a business credit card or losing the job altogether because you can’t get the supplies you need. Plus, you can always add that additional bit of interest into the price of the job – passing the higher interest cost along.
The bottom line is, if you use business credit cards for what they are intended to be use for – short-term working capital and don’t keep large balances on them for extended periods – then they will function very well to cover the working capital needs of your business.
Thus, when that new, large customer does come along – you can jump right into to completing that order and refill your coffers with the resulting profits.