Business lines of credit can help companies in numerous ways. These financial tools can provide the capital needed for growth opportunities or offer funds for emergency needs in tough times. A line of credit can also help business cash flow, making it easier to balance expenses every month. To get these benefits, though, business owners must understand how credit lines work. That’s where this simple guide can help.

What Is the Difference Between Lines of Credit and Loans?

One of the first questions for business owners has been related to the structure of credit lines. It often helps to think of them as an improved version of a business credit card. Like a credit card, a line of credit offers available funding without requiring businesses to use it. The funds are there, but the business decides when and how to spend them. Interest is only charged on the amount of funding used.

This is very different from the way a loan works. With business loans, interest kicks in immediately. The complete amount of funds is deposited in the recipient’s bank account as a lump sum. Monthly payments cover the loan’s principal and include interest. On the other hand, with a line of credit, businesses only need to make monthly payments if they have an outstanding balance from making a purchase.

Loans have their uses. A long-term loan provides lower interest rates for large purchases, such as heavy equipment or real estate. Lines of credit have higher interest rates but far more flexibility. They can cover small essentials, medium-sized purchases, and large-ticket items as needed.

What Are Revolving Lines of Credit?

Many business credit lines are set up on a revolving basis. This means that the funds can continue to be used for as long as the agreement lasts. For example, if a business uses $1,000 to purchase inventory, and pays back the $1,000 a few months later, those funds become available to use again.

It’s possible to use the line of credit for a few large purchases or many smaller ones. The business owner decides how to manage the funds. The line of credit includes a total spending cap based on various approval factors, such as credit score, time in business, and annual revenue.

What Factors Are Needed to Qualify?

The approval process varies by lender. Sometimes, lenders have a minimum credit score requirement or want business owners to provide a personal guarantee. Others require collateral. There are programs to help startups and small business owners qualify.