Understanding Business Lines of Credit: A Cautionary Tale

A business line of credit is not the same as a term loan, and this distinction is crucial, especially when considering the way newer lines of credit in the alternative/online lending space accrue interest.

Recently, we worked with a business owner client who owns a $3M/year wholesale distribution business. As a distributor, they move large quantities of inventory and frequently need to restock. Buying in bulk allows them to take advantage of discounts, but it also means they require significant capital to make these purchases. Depending on the time of the month and the volume needed, this can lead to cash flow challenges in other areas, like payroll, rent, and taxes.

A business line of credit was a perfect solution, and we got them approved for up to $100K in just 4-5 hours. The application process was simple—just an application, bank statements, and a voided check. Once approved, they had the flexibility to draw funds as needed.

However, while the product is easy to secure, it’s not always the most affordable option. The approval was for $100K at 3.83% simple interest per month, with an 18-month repayment term. If they drew the full $100K on day one, and made monthly payments of $7,792 over the 18 months, they would end up paying approximately $140K in total, which is a 40% total cost of capital. Ouch!

This is a common scenario we see. Many business owners get excited about having a line of credit, assuming that the flexibility to draw and repay funds at will means the cost must be manageable. They figure that as long as they can handle the payments over 12 or 18 months, the cost won’t be too high because, after all, it’s "just a line of credit." We’ve heard this reasoning from countless business owners.

In the case of our wholesale distribution client, they now have access to $100K. Their plan is to tap into $25K-$50K once a month or every other month to take advantage of deep discounts from suppliers and then pay off the balance as they flip the product or when cash flow improves.

For instance, if they pull $50K and hold the balance for 30 days before paying it off, they will pay back the principal plus an additional $1,916, or 3.83%, which is their cost of capital. Holding the balance for 60 days would result in a total cost of $3,757. These figures are manageable considering the markup they earn on the products and the ease with which they can access the funds.

At the end of the day, it’s all about how you use the line of credit. Be strategic, and make sure the flexibility works in your favor rather than becoming a costly burden.

fundu Business Funding, a division of Pineyro Group of Companies, proudly supports businesses of all sizes by providing the funding they need when traditional banks decline. Since our inception, we have provided over $3 billion in funding to business owners. Our diverse product offerings include Revenue Advances, Unsecured Business Lines of Credit, Purchase Order Funding, Invoice Factoring, Equipment Financing, and much more. In many cases, we can secure funding with no collateral, no income verification, and within 24 business hours.

To learn how Fundu Business Funding can assist you, contact us at 833-247-5626 ext. 701 or email [email protected]