Is a Line of Credit Right for Your Business Recession Plan?

According to a June 2022 Goldman Sachs survey, more than 90% of small business owners fear they could experience an economic recession in the next 12 months.

As lenders tend to tighten their lending standards during recessions, small business owners may be looking for ways to secure funds before access to credit may be curtailed.

One option to consider is applying for a line of business credit—even if you don’t need it right now. Unlike a business loan, a line of credit allows you to decide when to withdraw money and how much to borrow, up to a set limit.

Would your business benefit from a line of credit?

Since it’s common for access to financing to decline during a recession, getting a line of credit before you need it can be a smart move, especially if you see the potential for future cash flow problems.

For example, if you plan to make large investments in inventory and materials, or take on projects that require significant cash outlays before receiving payment from your customers, a line of credit can help ensure you have funds to do so in the future do.

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In addition, a line of credit can be used to cover operating expenses such as rent, wages, insurance, and maintenance if your business experiences a short-term drop in revenue.

In general, lines of credit are a good option for companies worried about fluctuating funding requirements, according to Carolyn Katz, a mentor at the New York chapter of SCORE, a nonprofit organization that provides education and mentoring to small businesses.

If you do decide to apply for a line of credit, “you should try to get whatever line of credit you have,” says Katz, “because even if it doesn’t fully cover your costs, a drawdown and regular repayments will help you earn it.” your way to a larger line.”

Are there disadvantages to a credit line?

If fluctuating cash flow is not an issue, your decision to apply for a line of credit is more complicated. While a line of credit could be used as a reserve or emergency fund during tough economic times, there are downsides to consider when obtaining one that might not be used.

It takes time to apply and fill out the necessary paperwork, the lender may charge a maintenance fee if you don’t use the line, and your limit may be lower than you’d like. Because lenders also look for unused lines of credit when evaluating a borrower, having a line of credit could adversely affect your ability to obtain other types of financing.

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What do you need to get a line of credit?

If the benefits of a line of credit to your business outweigh the disadvantages and you decide to apply for one, lenders will typically review your business’ viability, your creditworthiness, and your receivables. Accounts receivable, the money customers owe for goods or services, represents future income that can be used to pay off your line of credit.

“Receivables are important for any type of credit product, but with lines of credit, your receivables are really the most important criteria,” says Katz.

Also keep in mind that there is a risk of non-payment with older receivables. Katz says, “If you’re considering a line of credit, try to keep your receivables under 60 days.”

When should you apply for a line of credit?

Shauna Huntington of the NAWBO Institute of Entrepreneurial Development, the nonprofit educational foundation of the National Association of Women Business Owners, says business owners who want a line of credit should consider getting it before they actually need it.

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“If they wait until they get this big order and they need the line of credit to produce it, it becomes harder to go to the bank and ask for that money at that point and process it quickly,” says Huntington.

With the ability to withdraw funds when needed, a line of business credit can be the right move for businesses worried about future cash flow issues. However, a line of credit dedicated solely to hedging your bets on an uncertain economy can be an unnecessary expense with few, if any, benefits.

This article was written by NerdWallet and originally published by The Associated Press.

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Lisa Anthony writes for NerdWallet. Email: [email protected]

The article Is a Line of Credit Right for Your Business Recession Plan? originally appeared on NerdWallet.

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