Working Capital Lines of Credit
A line of credit sets a maximum amount of funds available from the bank, to
be used when needed, for the ongoing working
capital or other cash needs of a business.
The lines are typically offered for renewable periods that range from 90 days
to several years, although extended periods are usually subject to annual
reviews by the lender. The maximum amounts vary greatly; interest rates usually
float and you pay interest only on the outstanding balance. Money is typically
used for daily operations, such as inventory purchases, and to cover periodic or
cyclical business fluctuations. Collateral
for the loan is often accounts
receivable or inventory.
From a lender's perspective, the adequacy of the borrower's cash flow is the
most critical consideration. A commitment fee may be assessed by the bank for
making a line of credit available to the borrower, even if the full amount is
never used. An established business with a sound credit history may be able to
obtain an unsecured revolving line of credit.
A commercial line of credit can, for better or worse, become
an "evergreen" never-ending debt to a small business.
Frequently, a small business will open a working line of
credit of, for example, $40,000. Because of the immediate cash
needs of the business, the credit line is quickly topped out.
The borrower's continuing cash shortage forces it to pay only
interest on the loan and the principal is not reduced.
Commonly, working capital lines of credit are reviewed
annually by the lender and they can either be renewed or called
due. However, while lenders typically want the line of credit to
carry a zero balance at some time during the annual period, the
competitive banking environment may lead a bank to continually
renew a maximized line of credit as long as the institution is
receiving timely interest on the loan. Evergreen lines of credit
become, in effect, indefinite term loans with a balloon payment
of principal that poses risks to both the lender and the