How to successfully use a business line of credit

Money tug of warIt seems to me that no manufacturing business can really survive without a credit line of some kind.  It’s a simple fact that if you are producing a product, you must pay for the materials to make that product long before you will be paid for the final product unless you can manage collecting payment in full when you receive the purchase order from your customer.

Most of your customers will ask for and deserve payment terms of some kind.  These payment terms usually state something like “Net 30 Days”.  This means that the customer promises to pay for the goods invoiced in 30 days from the date of the invoice.

Let’s look at a timeline example.  You purchase materials to make a certain product and receive Net 30 Day terms from your supplier.  If it takes you 30 days to make the product, then payment will be due to your supplier at about the same time you are invoicing your customer for the product.  However, you will not be paid by your customer for another 30 days from the invoice date.  There is a 30 days gap in your cash flow here if you want to maintain good credit with your supplier and I highly recommend that you do so.  So here is where the credit line is applied.  You “borrow” the money from your credit line to pay your supplier and then repay the credit line when your customer pays you.  Please notice the REPAY part.  A credit line is not there for you to go deeper in debt.  Its function is to assist with the flow of your cash.

Credit lines can take on different forms and I have used two.  The most desirable is to have a savings account of your own money that you treat as a credit line.  The next most desirable is to obtain an unsecured line of credit from your bank.  This can sometimes be difficult to obtain.

You may wish to obtain a secured line of credit based on the equity in your home or some other asset.  Be very careful here since you are putting up as collateral the equity in your asset and could lose that asset if you cannot repay the line of credit granted. no credit card

The least desirable is to use a credit card unless you can absolutely guarantee that you have worked out a system to pay the credit card in full every month to avoid heavy interest charges.  The only exception here is if you can negotiate a lower interest rate for this credit card of around 6% per year or less on the unpaid balance which at the time of this writing is a reasonable interest rate for a line of credit.

Please track-track-track what the burden is on your credit line.  I have set-up a system whereby I constantly monitor the condition of my credit line.

The system is in the form of a spread sheet that records by customer invoice number the amount owed to me on that invoice and the amount owed to the parts supplier(s) for that invoice.  Hopefully, the former amount is greater than the latter amount or I should get out of the business!!  If I pay the supplier(s) before I receive payment from my customer for this particular invoice, then the amount paid to my supplier(s) becomes a burden on the credit line.

When I receive payment for that open invoice, then the burden is relieved or credited back to the credit line.  Obviously, the credit line total burden needs to be monitored.  If it gets too high, I may run out of ceiling on the credit line and my interest payments may become significant.  If you find this to be a problem in your case, you may wish to consider asking for longer payment terms from your suppliers and doing a better job of getting paid in a timely fashion from your customers.

Track the age of the burdens on your credit line.  A healthy credit line burden total will constantly have the old burdens replaced by new burdens.  You do not want to carry your customers for extended periods of time as an old credit line burden.  An ideal scenario is that you can accumulate your profits to be used as a future credit line so that you can gradually wean yourself from needing the credit line.  Please remember I said ideal scenario.

Continued use of a credit line is not a bad thing so long as it stays under control.

How have you successfully managed your cash flow? Did you use a line of credit? Share your story in the comments below.

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