It’s been said that the business world runs on credit – a sobering thought in these days of economic uncertainty. But what does that mean, exactly?
CRBJ weighed in with some coast financial professionals about business credit lines, and the role banks and credit unions play in the ebb and flow of commerce.
Spend now, pay later
While it may be a laudable goal to never spend more than you have, that’s not the way businesses generally operate, especially manufacturing enterprises. That’s where credit lines come in.
"A line of credit is a loan extended to a business that can be paid back at any time, and an advance can be taken out at any time," said Robert Blumberg, CEO of the Wauna Federal Credit Union.
Credit lines typically operate on a year-to-year basis, and are for a specific amount.
Businesses use them to handle seasonal or cyclical needs for cash.
"Credit lines are used to fill the gap between the time a business takes to provide a project and when they get paid for selling it," said Heather Seppa, Bank of Astoria’s executive vice president and regional retail banking manager. "When they’ve sold their product, it becomes a receivable, and then they receive payment for it."
The idea is that once a business gets paid for the sale of their products, they use the cash to repay the line of credit, so it’s there when they need it again.
"Then you reduce your credit and the excess is profit," Seppa said.
Steve Ferber, president and CEO of Compass Community Bank, said most businesses need cash to support their working capital needs, and to pay upfront expenses. But many small businesses simply do not have large financial reserves.
"Manufacturing costs money; selling costs money," he said. "You don’t get paid right away. A line of credit funds that manufacturing and selling. You spend money up front and pay later."
Dos and don’ts of credit line spending
Spending money first, and paying it back later is a good strategy when it’s done in a balanced way. But credit lines are not for just any spending.
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Credit line advice for small businesses
First of all, not all businesses need a line of credit. Credit lines are primarily for firms that are producing products or services in which there’s a cyclical nature to the business — where entrepreneurs must spend significant sums of money before they can make a profit.
• Check out options from the Small Business Administration, which offers a variety of loan guarantees that can help make it possible for banks to lend money to a small business.
• Consider separating your business credit from your personal credit. This is related to what form your business takes: are you doing business as a corporation or as a sole proprietor? Sole proprietor status makes your personal finances vulnerable if your business gets into trouble.
• When seeking a line of credit, look to smaller financial institutions that are more interested in serving local small business.
• Look to vendors to extend lines of credit on goods you need to produce your product.
• There are two types of credit lines: secured and unsecured. A secured line of credit is backed by the assets of the business. An unsecured line relies on the credit rating of the business, and represents more of a risk for the lending institution.
• Pay your bills on time to keep your credit rating solid – a factor that will be considered when obtaining and keeping a credit line.
Sources: CNNMoney.com, Fortune Small Business, National Federation of Independent Business |
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Seppa said it’s important for businesses to understand what their credit lines should be used for, and what types of expenses are not appropriate.
"One mistake businesses sometimes make is to use the credit line for equipment instead of for inventory they will get paid for," she said, adding that sales from inventory are what’s used to pay down the credit line.
Blumberg agreed.
"Some businesses have cash on hand but use a line of credit anyway," he said. "They invest cash in equipment that will help make the business more profitable and increase sales."
He said credit lines should also not be used to simply keep the business running, despite the temptation in slow times.
"Credit lines should not be used to fund operations," he said. "Some businesses run up a line of credit and then run out of money."
Credit lines vs. credit cards
Another type of business credit is the business credit card. That’s not the same as a credit line, and should be used for different purposes.
"A business credit card is used by sales people for expenses, traveling, meals, etc.," said Ferber. "A business credit card might have a $10,000 limit, for example."
Credit lines, Ferber said, are usually for a much larger amount, like $250,000 to $500,000 – or more.
"There are local businesses here that have credit lines of $1.5 million."
Seppa said business credit cards should be used for incidental expenses only.
"The rate on a credit line is generally prime to prime plus 3 percent," she said, a considerably lower rate than credit card interest.
Have the rules for borrowing changed?
Media reports on the national financial scene are filled with stories about banks that won’t lend. But is that the case here on the coast?
All three financial experts CRBJ interviewed said no. But that doesn’t mean a line of credit is a breeze to get. Regulations still apply.
"We are applying the same rules," Blumberg said. "We’ve always had conservative guidelines – that’s why we are not having problems now."
Blumberg said Wauna has not cut back on issuing credit lines, but they do routinely evaluate lines of credit when they come up for renewal.
"We look at current financial situations," he said. "We will try and accommodate them; we’re doing everything to work with businesses."
Still, he said in a financial downturn it’s primarily local, small businesses that are most severely impacted.
If a business is not doing well and no longer qualifies for a credit line, the loss of that loaned funding can create cash flow problems that can cause a business to fail.
Ferber said that Compass Community Bank’s rules for issuing credit lines also have remained consistent – it’s business that’s changed in the difficult economic climate.
"There are fewer customers and the need for a business may be lower," he said. "Their financial status may have changed, so they don’t look as good financially."
Seppa said changes in a firm’s status could make it hard to meet those same rules that allowed it to qualify originally. Despite banks willingness to support local business, the bottom line is the same everywhere – borrowers must be able to demonstrate that they are good risks.
"Losses, layoffs – that might change their eligibility," she said. "We have been following the philosophy that you have to be able to show you can [re]pay."
New businesses are at the greatest disadvantage in applying for credit.
"We look at past history, past performance, if they are profitable, if they are making money," said Blumberg. "If it’s a startup business there’s a lot of risk for us. If they’ve been around for three years or more it’s better."
Still, Blumberg said a local financial institution is the best bet for a small business seeking credit.
"Small businesses will be supported by local financial institutions," he said. "Larger banks don’t always do smaller lines of credit."
The light at the end of the tunnel isn’t an oncoming train
"We have good things [happening] here," said Ferber of the regional economy. "The economy is not as bad here on the coast as in other parts of the Northwest."
Blumberg was likewise cautiously optimistic.
"I’m seeing light at the end of the tunnel," he said. "I’ve started to see positive news."
He ventured a guess that the third quarter of the year might show real improvement in the economy.
But all three financial experts offered the same theme of encouragement for small businesses on the coast.
"The message," said Ferber, "is ‘we have banks in the area that are ready to lend locally.’"