In business finance, companies often find themselves navigating an array of lending instruments. In order to sustain growth, businesses need financial tools we refer to as “best fit”. Among these tools is a Business Lines of Credit (or BLOC), a form of asset based lending. The BLOC emerges as a versatile financing option, providing vital liquidity precisely when it’s needed most. Also, the best part about a BLOC is that the business only pays for what it uses, and they pay interest only. In this article, we delve into the intricacies of business line of credit, what it takes to qualify, and what options might be available if you don’t.
Understanding Business Lines of Credit
A business line of credit is a flexible financing option extended by financial institutions, and popular among banks. A line of credit enables businesses to access funds up to a predetermined limit. Unlike traditional loans, where a lump sum is disbursed upfront, a line of credit allows borrowers to withdraw funds as needed. This feature renders LOCs particularly suitable for managing short-term cash flow needs, seizing growth opportunities, or mitigating unforeseen expenses. Most times, funds are used for working capital (i.e. financing Cost of Goods Sold). Additionally, the best part about a line of credit is that the borrower pays interest only. This has significantly less of an impact on cash flow than a traditional, amortizing loan.
Liquid Assets Required for a Business Lines of Credit
The approval and size of a Business Line of Credit are contingent upon various factors, mostly a business’s short-term assets. These assets serve as collateral, providing assurance to lenders and influencing the credit limit granted to the borrower. Among the primary short-term assets considered by lenders are receivables, purchase orders, and inventory, each with it’s own advance rate.
- Accounts Receivable – generally financing companies will offer up to 60-70% of the total invoice amount.
- Purchase Orders – financing companies will offer 50% to 100% of the cost of goods sold, often times depending on whether or not receivables are included in the collateral.
- Inventory – the advance rate is lower in inventory since it’s a less liquid asset than receivables; generally, the advance rate is 50-60%.
Receivables: The Cornerstone of Liquidity
Receivables, representing outstanding invoices owed to the business by its customers, are prized as highly liquid assets. Lenders typically assign a higher advance rate to receivables due to their readily convertible nature (i.e. invoices convert into cash within 90 days). This advance rate often hovers around 70% to 90% of the receivables’ value, providing businesses with a substantial portion of their outstanding invoices’ liquidity.
The devil is in the details. When shopping for a line of credit, it’s imperative to understand the “Eligibility Requirements” which determine how much capital you can secure under the line.
Hanna Kassis, founder, Babylon Asset Management, LLC
More eligibility requirement information on a receivables line of credit.
Purchase Orders: Fostering Future Growth
For businesses engaged in manufacturing or retail, purchase orders (“POs”) mean future revenue. Lenders extend credit lines based on the cost of goods sold under a PO, allowing businesses to finance the procurement necessary to fulfill them. While purchase orders contribute to the creditworthiness of a business, the advance rates associated with them may vary based on the perceived risk and feasibility of fulfilling the orders. Generally, the advance rate is 50-100% of the cost of goods sold.
Inventory: Balancing Liquidity and Risk
Inventory, comprising finished goods or raw materials, occupies a pivotal yet nuanced role in a line of credit deal. Unlike receivables and purchase orders, inventory’s liquidity is subject to greater uncertainty and market fluctuations. Consequently, lenders exercise caution when assessing the advance rate on inventory, often offering lower percentages of its value as collateral compared to receivables. Generally, the advance rate is 50-60%.
More eligibility requirement information on a receivables line of credit.
Tailored Business Lines of Credit for Diverse Assets
Recognizing the unique characteristics and risk profiles of different short-term assets, financial institutions may offer tailored Business Lines of Credit or “revolvers” to businesses. These specialized credit facilities cater to the specific financing needs arising from receivables, purchase orders, or inventory, providing businesses with targeted liquidity solutions aligned with their operational requirements.
Strategic Implications for Businesses
The judicious utilization of Business Lines of Credit can confer strategic advantages upon businesses, empowering them to seize growth opportunities, navigate seasonal fluctuations, and optimize their working capital management. By leveraging the liquidity embedded within their short-term assets, businesses can enhance their operational agility, accelerate revenue cycles, and fortify their financial resilience against unforeseen disruptions.
Final Thoughts on a Business Line of Credit
In the realm of Business Lines of Credit, Babylon stands out as a trusted partner for well-established businesses with annual sales ranging from $1 million to $100 million. With a deep understanding of the intricate dynamics of business finance, Babylon offers tailored credit solutions that harness the latent liquidity residing within receivables, purchase orders, and inventory. Through strategic collaboration and unwavering commitment to client success, Babylon empowers businesses to unlock their full potential and thrive in an ever-evolving marketplace. Embrace the power of Business Lines of Credit with Babylon, and embark on a journey towards sustained growth and prosperity.