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Tata Capital > Blog > Loan for Business > Business line of credit explained: Meaning, types, uses & key benefits

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Business line of credit explained: Meaning, types, uses & key benefits

Business line of credit explained: Meaning, types, uses & key benefits

Access to cash at the right time can decide whether a business runs smoothly or struggles. Sales delays happen. Payments may not arrive on time. However, expenses do not wait. This is where a business line of credit quietly becomes one of the most useful financing tools for companies.

Unlike a traditional loan, it gives flexibility. You can borrow only when needed. You can then repay and reuse. No rigid structure. No unnecessary interest burden. The interest is charged only on the amount you use.

Keep reading to learn more about the business line of credit.

What is a business line of credit?

A business line of credit is a revolving credit facility offered to businesses. Here, a lender approves a maximum loan limit based on your business profile. You can borrow funds from this limit as and when required. Interest is charged only on the amount used, not on the entire loan limit.

You can repay and reuse the same limit. This means that once you repay the borrowed amount, your loan limit is automatically reset. A business line of credit is an ideal tool for managing short-term cash flow needs without repeatedly applying for long-term loans.

How does a business line of credit work?

As a business owner, you can apply for a business line of credit in India with banks, Non-Banking Financial Companies (NBFCs), and Fintech lending platforms. Based on your business income, cash flows, credit history, experience, and repayment capacity, you will be sanctioned a credit limit. You can, then, withdraw funds multiple times within this limit.

There is no fixed schedule for repayments either. Based on the lender’s terms, you can choose to repay based on your cash flow status or through Equated Monthly Installments (EMIs). The interest is charged only on the amount you borrow and for the specific duration for which you’ve borrowed.

Types of business line of credit available in India

Based on whether you are offering collateral or not, lenders provide two distinct types of business line of credit in India. While they both serve the same purpose, they differ in terms of eligibility, interest rates, and lending terms.

●      Secured business line of credit

A secured business line of credit is offered against collateral. It can be a real estate property, business inventory, machinery, or even investments. Interest rates are usually lower, and credit limits are higher. Such a facility is useful for business owners who can pledge their personal or professional assets.

●      Unsecured business line of credit

An unsecured business line of credit isn’t backed by collateral or security. Approval mainly depends on your business stability, annual turnover, and credit score. The interest rates are usually higher, but approval is faster. This option is suitable for business owners who do not wish to pledge their assets.

Common uses of a business line of credit

A business line of credit is primarily meant to handle short-term or unexpected financial needs. It gives you quick access to funds during emergencies or temporary cash shortages. You can draw money when required, repay it once your cash flow improves, and then reuse the same limit again.

However, a line of credit is usually not suitable for long-term investments or asset purchases. In such cases, term loans are a better fit.

Here are a few practical scenarios where a business line of credit proves useful:

●      Managing short-term cash flow gaps

Cash inflows and outflows rarely move in sync. You may have pending invoice payments, but salaries, rent, or suppliers won’t wait. In such situations, a business line of credit can help you bridge the gap. You can borrow funds from it to meet urgent cash flow requirements and repay them once you receive your payments.

●      Funding inventory and daily operations

A business line of credit can be a highly useful tool for those in seasonal businesses. It helps stock inventory without disturbing regular operations. For example, if you are handling a traditional wear shop for men and women, you can use a business line of credit to buy additional stock before the festive/wedding season. The amount can be repaid gradually as sales pick up.

Eligibility criteria for the business line of credit

Business line of credit requirements may vary from one lending institution to another. Most look at a few core factors, which include:

  • Business vintage: Your business vintage or experience plays a critical role. Lenders usually offer a business line of credit to companies that have been in operation for at least three years.
  • Annual turnover: Lenders also look at your business’s annual turnover and profit when approving your line of credit application. They might need you to cross a specific threshold.
  • Credit profile: Your credit profile comprises your loan repayment history, credit score, and existing debt liabilities, among others. Lenders carefully evaluate these factors to make sure you are capable of handling a new credit limit.

Documents required to apply for a business line of credit

When you apply for a business line of credit, you are required to submit certain documents to prove your eligibility. The lender, then, carefully verifies these documents and approves your application only if everything is in order. Here is a list of documents commonly required:

  • KYC Documents – PAN Card, Aadhaar Card, Voter’s ID Card, etc.
  • Proof of Business – Business Incorporation Certificate, GST Registration Certificate, etc.
  • Recent bank statements and Income Tax Returns
  • Licenses and permits (if applicable)
  • Other financial documents, such as P/L statements, audit reports, etc.

Note that your lender may ask for some additional documents at the time of loan processing.

Example of how a business line of credit works

Let’s understand how a business line of credit works with the help of an example. Suppose a business has an approved line of credit of Rs. 20 lakhs. The applicable interest rate is 12% per annum. On 1st May, it withdraws Rs. 2 lakhs to make payment to suppliers. After 10 days, i.e., on 11th May, the business withdraws another Rs. 3 lakhs to manage payroll. The total outstanding now becomes Rs. 5 lakhs.

In such a case, interest will be calculated separately based on the number of days each amount is used. If the business repays Rs. 5 lakhs on 25 May, interest shall be charged on Rs. 2 lakhs for 25 days and on Rs. 3 lakhs for 15 days. The entire limit will be made available once again for future use.

Advantages and limitations of a business line of credit

Like any other financial tool, a business line of credit entails both advantages and limitations. Understanding them can help you make better borrowing decisions.

Advantages

  • Flexibility in withdrawals and repayment.
  • Funds can be accessed anytime within the limit.
  • Interest is charged only on the amount used.
  • Helps maintain business continuity during slow cycles.
  • Eliminates the need for multiple term loans.

Limitations

  • Collateral or a guarantor may be required.
  • Involves processing fees, annual maintenance charges, and other expenses.
  • Over-borrowing may increase financial burden.
  • Interest rates can be on the higher side.

Business line of credit vs business loan

A business line of credit allows you to borrow multiple times from a revolving credit facility. A business loan, on the other hand, involves borrowing a certain amount that has to be repaid over a pre-determined period along with interest. A business line of credit is useful for meeting short-term working capital requirements, whereas a business loan is ideal for long-term purposes, such as procuring equipment or office space.

The table below depicts a comparison between these two financial tools:

ParameterBusiness Line of CreditBusiness Loan
StructureRevolving credit facilityOne-time disbursal
UsageShort-term and emergency needsLong-term investments and asset purchases
InterestOnly on the amount usedOn the full loan amount
RepaymentFlexible, based on usageFixed EMIs over a set tenure

How to apply for a business line of credit online?

You can apply for a business line of credit in the following steps:

1. Compare and finalize a lender

Compare business line of credit rates and other parameters to zero in on a lender.

2. Visit the lender’s website

Visit the official website of the bank, NBFC, or Fintech lender you’ve selected.

3. Fill out an online application form

Fill out the online application form on the lender’s website to apply. Make sure you enter the required details accurately.

4. Upload the required documents

Upload the required documents on the lender’s website. Make sure the documents are complete and precise.

5. Wait for the verification

Wait until the lender verifies your loan application and documents. The process may take a few business days.

6. Approval and disbursal

Upon successful verification, the lender will approve and disburse your credit line. You can start borrowing immediately.

Final thoughts

If used smartly, a business line of credit can be a very powerful financial tool. It offers the flexibility that traditional loans often lack. You can borrow, repay, and reuse, as per your evolving cash flow requirements.

However, it’s crucial to avoid over-borrowing and choose an appropriate lender. Comparing interest rates, lending terms, eligibility criteria, and hidden charges can help you apply for the best small business line of credit available.

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FAQs

How is interest charged on a business line of credit?

Interest on a business line of credit is charged only on the amount actually used, not on the approved limit. It is usually calculated on a daily basis and billed monthly. As repayments are made, interest reduces accordingly, keeping borrowing costs under control.

Can MSMEs apply for a business line of credit?

Yes, MSMEs can apply for a business line of credit. Banks and NBFCs commonly offer this facility to small and medium businesses with stable cash flows and a good credit history. Eligibility depends on business vintage, turnover, and the lender’s terms and conditions.

Is a business line of credit renewable?

Yes. A business line of credit typically comes with the annual renewable feature. Lenders review the account periodically based on repayment behavior, business performance, and credit profile. If the review is satisfactory, the facility is renewed for another term.  

Who is eligible for a business line of credit?

All businesses with a minimum operating period, stable revenues, and satisfactory credit history are eligible for a business line of credit. Lenders assess these factors based on the documents submitted at the time of application.

What is the difference between a business loan and a line of credit?

A business line of credit allows you to borrow multiple times from a revolving credit facility. You can repay and reuse the same limit. A business loan, on the other hand, involves borrowing a certain amount that has to be repaid over a pre-determined period along with interest.  

Is a business line of credit secured or unsecured?

A business line of credit can be both secured and unsecured. If it is backed by collateral or security, it is referred to as a secured line of credit. If no collateral is involved, a business line of credit is said to be unsecured.

What can a business line of credit be used for?

A business line of credit is best used to tackle short-term cash flow gaps and emergency financial requirements. For example, paying salaries to employees if receivables are delayed, buying inventory for peak season demand, etc.

How much credit limit can I get on a business line of credit?

The credit limit on a business line of credit depends on factors like your annual turnover, cash flows, existing liabilities, and credit history. It may also depend on the value of collateral (in the case of a secured line of credit). The decision solemnly rests with the lender.

What are the interest rates on a business line of credit?

The business line of credit rates in India generally range between 9% and 21% per annum. The exact rate depends on the lender and the borrower’s credit profile, business experience, and whether the facility is secured or unsecured.
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