Education Library · Foundations · Article 10
Say a plumbing company has a $100,000 line of credit with its bank. In July it finishes a $60,000 commercial job on net 45 terms, but payroll and the supply house bill are due now. The owner draws $40,000, covers both, and pays the line back when the customer’s check clears in September. Interest ran on $40,000 for about two months. The unused $60,000 cost nothing, or close to it, and once the balance was back to zero the full $100,000 was available again.
That’s a line of credit, often shortened to LOC. The lender approves a maximum amount, and the business borrows against it as needed, pays it down, and borrows again.
Draw, repay, revolve
You don’t get a lump sum on day one. You draw what you need, usually by transfer into your business checking account, and interest is charged only on the outstanding balance. Paying it down frees that amount back up. That cycle is why lines are called revolving credit.
Payments vary by product. Many bank lines require monthly interest on the balance, with principal paid down whenever cash comes in. Some online lines turn each draw into its own short repayment schedule, with fixed weekly or monthly payments over a set number of months. Two products with the same limit can put very different pressure on your checking account.
Some lines also carry annual, draw or unused-line fees, which belong in the cost comparison alongside the rate.
Bank lines and online lines
Bank and credit union lines usually have lower rates and longer relationships, but more paperwork. Expect to provide two or three years of business and personal tax returns, current financial statements, bank statements, and a personal financial statement from each owner. Most banks also want to see the business has been operating for a while. As Paul put it on one call: “A lot of lenders are going to want two years in business.”
Online lines tend to approve faster and lean more on recent bank deposits, often the last few months, than on tax returns. The trade-off is usually higher cost, shorter repayment and smaller limits.
Watch the label. Some products marketed as a line of credit are actually merchant cash advances, repaid as a percentage of daily sales. One young home service company, doing around $35,000 to $40,000 a month, was offered a “line of credit” inside the software it used to run jobs. The owner described the repayment: “it’s paid back by 17% of your daily sales over time.” With sales running “some days it’s $8,000, some days it’s, you know, $1,000,” the payment swung with every deposit, and working out the true cost wasn’t simple. Paul’s read on that product: “it’s actually not a line of credit.” A real line has a stated rate on the balance you carry and lets you decide when to draw.
Secured and unsecured
An unsecured line isn’t tied to specific collateral, though nearly all of them still require a personal guarantee from the owners. A guarantee means that if the business can’t pay, the lender can come after you personally.
Secured lines are backed by business assets, most often accounts receivable and inventory, sometimes equipment or real estate. Many secured lines use a borrowing base, where the amount you can draw is a percentage of your eligible receivables or inventory, updated monthly or quarterly. If receivables drop, so does what you can borrow, even if the approved limit didn’t change. Lenders usually file a UCC lien, often a blanket lien on all business assets, which the next lender will see when it searches your company.
Renewals and clean-up periods
Most bank lines aren’t permanent. They’re typically approved for a year and then reviewed. At renewal, the lender asks for updated financials and tax returns and decides whether to renew, change the limit, change the terms or not renew. A weak year or a tax return showing a loss can change the answer even if you never missed a payment.
Some lines include a clean-up requirement. The business has to pay the balance down to zero, and keep it there for a period, often 30 days, at some point during the year. The lender is checking that the line is funding short-term needs and isn’t permanent financing in disguise.
What banks look at
The review usually covers:
- Time in business and revenue trend
- Profitability and cash flow on tax returns, not just internal P&Ls
- Average bank balances and deposit consistency
- Existing debt and liens
- Personal credit of the owners, since most lines carry a guarantee
- Receivables quality for secured lines: who owes you, how old the invoices are, and how concentrated they are in a few customers
Timing matters. Lenders generally want to see several consistent months, and a line is easier to get when things are going well than in the middle of a cash crunch. One home service company in its busiest month on record, with referral and labor costs climbing alongside revenue, wanted a line in place before it needed one. Their operator said it was better to “be proactive rather than trying to react to a cash crunch in two weeks.” Getting there still depended on the tax return, the owner’s personal credit and a few more months of financials.
Short-term gaps, not long-term purchases
A line is built for timing gaps: payroll before a customer pays, a big materials order before a job starts, a slow winter after a strong fall. The money goes out and comes back within weeks or months.
Using a line to buy a truck, a piece of equipment or another company ties up the line for years with something that should be on its own loan. The line is then unavailable for the gaps it was meant to cover, and a balance that never comes down shows up at renewal.
How lines compare to term loans and cards
| Line of credit | Term loan | Business credit card | |
|---|---|---|---|
| How you get the money | Draw as needed up to a limit | Lump sum up front | Purchases and sometimes cash advances |
| Interest | Only on what’s drawn | On the full loan from day one | On balances carried past the grace period |
| Repayment | Flexible, often interest-only on the balance, or per-draw schedules | Fixed payments over a set term | Monthly minimum, revolving |
| Best fit | Working capital and timing gaps | Equipment, vehicles, real estate, acquisitions | Everyday spending, smaller purchases |
Cards are also revolving credit, but limits are usually smaller, rates on carried balances tend to be higher, and they’re meant for purchases more than for covering payroll. Term loans fit things the business will use for years.
This article is educational and isn’t legal, tax, accounting or lending advice. Program rules, lender terms and credit bureau practices change, so verify current terms before acting.
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