What is a line of credit and how can it help you support your business?

What is a line of credit?

O line of credit is a financial instrument offered by banks or other financial institutions, which gives you access to funds as they are needed, until reaching a set maximum ceiling. Its operation is similar to that of a credit card, but with greater flexibility in terms of the use of funds. This financial system is revolving, which means it automatically renews itself as collections are made, providing a constant flow of funds for your financial needs.

Funds from a line of credit can be used to cover temporary working capital shortfalls, such as paying suppliers, salaries, taxes or other current expenses. This financial instrument offers the flexibility to use any amount of money, up to the maximum approved limit, depending on the payment needs generated by your day-to-day activity.

The value of the credit line is established based on an analysis of your business and is correlated with its financing needs. This funding requirement is determined by the time interval that elapses from the moment of making payments to suppliers to the moment of collection of amounts from customers.

How a line of credit helps you: example

Let’s say your business frequently experiences gaps between receipts and payments. Because of these fluctuations, managing day-to-day operations becomes a challenge, and a lack of funds in the current account can affect both supplier relationships and customer confidence.

To better manage these needs, apply for a credit line of 100,000 lei. In the approval process, the bank will ask you for relevant financial documents to assess your credit history (if any), income stability and ability to pay off any debts. After the line of credit is approved, you will have access to the necessary funds to cover unexpected or temporary payments.

If in a month you use only 50,000 lei of the 100,000 lei approved, you will pay interest only for the amount used. The remaining 50,000 lei will remain available in the account, giving you flexibility for other urgent needs or unforeseen situations.

Thus, the line of credit allows you to maintain a steady cash flow without affecting your equity.

How does the bank determine the value of the line of credit?

Determining the value of a line of credit is a complex process that involves a detailed analysis of your business. The bank will start by reviewing the financial history of your business. It will look at the balance sheets, net profit and cash flow of your business. At the same time, she will assess your current financial situation to understand how capable you are of paying off your debt.

The value of the line of credit is then matched to the financing needs of your business. The financing requirement is the amount of money a business needs to cover its current expenses and sustain its growth. It is calculated as an average of the time that elapses between when payments are made to suppliers and when amounts are collected from customers. This represents the actual period during which a business would need money.

For example, if your business has a receivables collection period of 45 days and a payables payment period of 30 days, the financing requirement would be 15 days. This means that, on average, your business needs funding for 15 days. The bank will use this calculation to determine the value of the credit line.

How can a line of credit help you support your business?

A line of credit can prove to be an extremely valuable financial tool. This gives you access to funds when you need them, allowing for greater financial flexibility. It is particularly useful for businesses that experience seasonal variations or periods of strained cash flow.

A notable advantage of lines of credit is that interest is charged only on the amount used. Unlike other forms of credit, with a line of credit, interest is calculated only on the amount used, not on the entire available amount.

In addition, the line of credit can be used to refinance existing debt. That means you can improve your cash flow by lowering your interest rate or consolidating multiple payments into one lower monthly payment. This can be especially useful if your business is dealing with a number of debts with different rates and payment terms.

The line of credit can support the sustainability and growth of your business. By accessing additional funds, a line of credit can help finance the expenses needed for business development and expansion. Whether it’s purchasing new equipment, hiring additional staff, or investing in marketing, a line of credit can be a valuable source of financing.

Therefore, a line of credit can be an extremely useful tool for any business, providing financial flexibility and helping to manage cash flow efficiently. However, to maximize the benefits and minimize the risks, it is essential that you have a clear understanding of how it works and use it responsibly as part of your overall financial strategy. In this sense, consultation with banking professionals can be an essential step in the financial planning process.