Which is best – business line of credit vs credit card — find out here.
If you’ve been in business for some time, you’ll understand that your cash flow fluctuates.
If you’re new to the business world, you may have already considered a financing option for your business. Or perhaps you’ve researched various online lenders for a small business loan to help you build your enterprise.
There may be times when your monthly payments and business expenses outweigh the income or when you need to make a big purchase, pay for a big launch, or a marketing campaign.
Juggling the money can feel like walking over a bit of a tightrope sometimes, so which financing option should you go for?
When financial times get tricky in your business, that tightrope you’re walking can seem like it’s on fire and the rope can get longer.
We’ve all come across the phrase ‘there’s too much month at the end of the money,’ that’s where a business line of credit or a business credit card can come to your rescue.
Using them carefully can be a great life raft to help you stay afloat in the choppy financial waters.
I have used both options in two separate businesses when I’ve needed cash, so I feel I’m well-placed to discuss some comparisons.
My personal experience says that sometimes the answer to which option is better for your small business can be obvious, but other times it can be more difficult to decide.
As there are many factors to consider, let’s look at both a Business Line of Credit and Business Credit Cards, assess their strengths, and their downfalls and try to find some answers together.
What is a Business Line of Credit and How it Works?
A business line of credit (Business LOC) is a specific amount of money that the bank will allow you to borrow. Your small business is assigned its own credit limit and a draw period. The credit limit is the maximum amount of money offered by a lender that your business is entitled to use.
The draw period is the number of months/years that your business has access to those funds.
During this time, your business can draw as much money as it likes up to the credit limit and only the amount of money your business uses incurs interest.
In these modern times of smart technology, you will likely use an app to withdraw funds – but you might also use a card or a checking account for your cash advance.
Your business’s credit line (which is the maximum funds your business may draw) will vary entirely depending on your company’s financial well-being, its credit history, and most importantly, the annual revenue.
It is common for small businesses to enjoy credit lines of up to $100,000, but you can see how this could be dangerous if not carefully managed.
Many entrepreneurs and business owners like to think of a line of credit as a flexible loan. They can also be secured against business or personal assets (a secured loan).
If it is an unsecured loan, then it is quite likely that the credit limit may be lower and carry a higher interest rate. Most business lines of credit are secured against personal or business assets.
The money is often referred to as a revolving line of credit, because if the balance is partially or fully repaid, then the owner can access the business line of credit as often as they like throughout the draw period.
And provided that your business does not exceed its credit limit, it can be an incredibly lucrative cash flow tool.
After the fixed end date, you would need to reapply with your lender to keep accessing the credit line.
If there have been no issues, then entrepreneurs may well enjoy this facility as a great assisting tool to build their business and, over time, may see their line of credit increase in line with the size of their business.
What is a Business Credit Card and How it Works?
You potentially have a personal credit card and understand how the process of using it works. Business credit cards share many similar traits.
The best way to use any credit card facility is to use it to make purchases throughout the month, repay the balance in full (usually within a 30 – 56-day term) and avoid paying interest on the balance that the business has borrowed.
Think of it as a relatively large pot of money to make purchases for your business. Whilst this can seem appealing to have that level of financial freedom – you don’t have to trawl the internet too far to find personal stories of how the stark truth of credit cards is that they can be financially crippling as well as being a useful finance tool.
Perhaps the greatest asset is that you need not use your business’s cash flow to make large payments upfront and can use profits from this month (and sometimes the following month) to avoid paying interest.
It is important to note that if you do not pay the entire balance in full, then your business will be liable for all the interest against the accrued balance. If your business has had a difficult month, it can be tempting to delay the repayment and just make the minimum payment – but this leads to higher rates of interest in the long run.
Most commonly, a credit card is unsecured. That has positives and negatives. The fact that it is unsecured may make it easier to obtain and your business won’t need to offer any collateral.
The downsides are the rates of interest are typically higher and the credit limit may be comparatively lower than in a business line of credit.
They can be a relatively straightforward way of building your business credit profile if you meet all your repayments on time. There are usually minimum earning requirements for your business and some banks will only offer the facility to certain types of companies.
Differences Between the Two
Imagine a business line of credit for a moment or two. It’s there quietly and patiently waiting in the bank ready for you to access at any time. And on the desk in front of you, your shiny business credit card is staring at you. Let’s say hypothetically, that you have access to both options.
And as a small business owner, you have a business expense that requires payment now (all entrepreneurs have been in that situation, right?) You’ve checked out personal finance options (personal loans, extending the mortgage of your home) and have concluded that it’s far better to leave the liability in the business – which would be the right decision, wherever possible.
Perhaps an opportunity has come along for you to acquire stock at a massively discounted rate, or there is the opportunity to work with a digital marketing agency to utilize a growing trend or opportunity staring your business in the face. Which financing option should you choose?
Making the right decision can be a painful one and cause sleepless nights.
Here are some differences to consider when making your choice:
Access To Funds
What I mean by this is access to cash. Cash advances are an option carried by many credit card facilities, but they can charge you a hefty sum for the privilege. A business line of credit typically does not discriminate against a cash advance. Business credit cards are often used for purchases rather than for using a revolving line of credit as part of your everyday cash flow.
Perhaps you have hired new staff and need to fund the recruitment process and first months’ wages, before the increase in personnel, has an impact on your bottom line – which inevitably it will if you’re building the business.
Let’s take a business that wants to add two members to the sales team. They know that by hiring two more individuals to make sales, they will be able to increase their monthly turnover by approximately $20,000, but the recruitment process and the first month’s wages will cost the business $10,000.
It’s important to note for this example, that the business in question doesn’t currently have ten thousand dollars lying around to freely be used – so a business line of credit would provide the perfect opportunity to undergo this recruitment without leaving a hole in the finances.
Interest Charges
With a business line of credit, the accrual of interest begins when your small business withdraws funds, and this is only based on the amount borrowed. Business credit cards tend to offer a grace period where no interest is charged to the business. Following this, interest is charged on the balance used regardless of the initial charges.
The revolving line of credit can function as a buffer for day-to-day business expenses, whereas a credit card is likely better suited for large purchases that may dent cash flow if purchased using company profits.
Credit Limits
When it comes to credit limits in both options, they are usually based on several factors. The policy of the lender, your personal credit history, your business’s credit profile, and the turnover of your business can all have an impact on the credit limit offered to your company in the form of a line of credit or a credit card.
Business lines of credit generally offer higher credit limits than business credit cards, making them a more favorable option for entrepreneurs looking to make large purchases or investments.
Rewards And Benefits
There can be some lucrative perks in a business credit card, which may seem particularly useful to small businesses in certain fields. Often, cashback rewards, travel perks, and points may be incentivizing for small business owners who may enjoy saving money elsewhere as a direct result of using the company card to make purchases.
Such rewards are unlikely to be found in a line of credit, but it’s important to note that the benefits of these perks may not outweigh the terms of a revolving line of credit.
The fact is, you can cover a credit card in confetti and chocolate buttons with as many perks as you like, but unless it is properly managed – the interest rates can be eye-wateringly high.
Flexibility in Repayment
Typically, the business line of credit is more flexible in its repayment terms than the business credit card. In general, a business credit line allows for interest-only payments on the amount that you’ve currently borrowed. Providing that you stay within your agreed credit limit and meet all the minimum payment requirements, there are no fixed monthly payments.
In contrast to this, business credit cards tend to set a minimum payment for each billing cycle. This will usually be a percentage of the total balance and accrued interest.
You should be aware that many banks offer introductory interest rates and trial periods, and these may last for 12 – 24 months. When this period elapses, keep in mind that interest rates will skyrocket and associated payments for your small business will vary.
Some business owners have the theory that they will switch between company credit card providers to enjoy multiple introductory offers, but keep in mind that all businesses go through good and bad periods of cash flow – and this may not be an option if your company credit rating is on a temporary downward spiral.
Usage
From my experience, Business Credit Cards are particularly useful for minor purchases and expenses such as office supplies, small-scale software, and business meals and entertainment. This is solely to do with their user-friendly nature and potential reward programs.
They can also provide you with a tool to improve the creditworthiness of your small business and make it more likely for your business to get credit later if the facility is managed appropriately.
Whereas a line of credit (Business LOC) may well be more suited to substantial one-time expenses or more ongoing operational costs. Typically, they offer larger amounts of capital and more flexible repayment options.
Conclusion
Nobody wants business finances to become a burden. Ultimately, you want whichever choice you make to help fuel business growth, not become a hindrance that will end in financial disaster.
The trick is to thoroughly research each option available to your business and where necessary, seek advice from a trusted financial advisor.
Whatever you choose should be guided by a clear understanding of the business itself, your knowledge of your business’s financial health, and the five-year plan for the journey of your business.
A business line of credit may well be more beneficial if you’re planning a significant investment that needs cash flow to make it happen.
For smaller, more tangible expenses – you might opt for the credit card option, because let’s face it – the majority of us have a personal credit card, so we understand the mechanics of how they work.
Research everything, make sure you’ve got a clear understanding, and above all – do what’s right for your business.
FAQs
Is a Line of Credit Better Than a Credit Card?
Every business is different and deciding between a line of credit and a credit card depends entirely on your business’s needs and circumstances. A credit line can provide your company with a bigger borrowing limit, and flexibility in repayment.
This makes it more suited to larger-scale investments or bigger monthly operational costs.
A business credit card can be ideal for smaller, more frequent purchases. You could also think of them as long-term vs short-term solutions.
To make the best decision, it really is crucial to assess your business’s current financial position, understand the terms of both options and above all else, consider seeking advice from a qualified financial advisor to make the right decision for your business.
How Many Lines of Credit Should a Business Have?
Figuring out the best count of credit lines for your enterprise depends the most on your unique monetary conditions and the specific needs of your business.
It is a straightforward concept, but in practice – it is much harder to get your head around because every entrepreneur’s business is unique. To take advantage of a business line of credit, your business should have adequate muscle to easily manage the repayments of any loans.
Multiple credit lines might enhance your available funds and better your cash inflow, yet they also bring in higher financial responsibility to you and your team. During your initial viability assessment, it is important to account for potential shifts in repayment should interest rates change.
It would be a wise move to seek advice from an expert financial advisor to understand what is optimally conducive to your company’s economic health and long-term strategy.
How Can I Use a Line of Credit vs a Credit Card for my Small Business?
When you are running a tight ship in a small enterprise, a line of credit acts as a trusty ally.
This financial tool is an ideal match for businesses that demand flexible, cyclic borrowing courtesy of its generous limit and appealingly low-interest rates based on the amount you ‘draw’ rather than the total amount borrowed.
On the flip side, a business credit card stands out in its efficacy in managing day-to-day expenses like office supplies, travel costs, or software subscriptions. Besides, it also proves beneficial in boosting your venture’s credit reputation.
Remember, choosing between these two options ultimately relies on your enterprise’s unique necessities and economic health.
I want to underline the importance of getting professional financial advice before settling on your choice. The critical thing to remember is that both these financial tools serve different purposes and have their own strengths.
So, understanding the needs of your business and aligning them with the right financial tool is key to a healthy financial future for your business.
