Lines of Credit Help Businesses Bridge Payment Cycles

YOUNGSTOWN, Ohio – Monitoring the cash flow of your business can be an intricate process, balancing the acquisition of inventory, ensuring clients make their payments and making sure that there’s enough money left at the end of the day to keep things running.

For many businesses, a line of credit is a vital part of the dance that, if properly used, can help fuel expansion. It exists to help businesses bridge the gap between spending money and earning it back.

“If you need to use it today, tap into it. If you receive a lot of payments from customers the next day and have the cash available, pay it down,” says Christopher Colella, vice president of commercial banking for First National Bank of Pennsylvania. “We have clients who are in and out of the line daily.”

That sort of turnover is what lines of credit are designed for, area bankers say. At Home Savings Bank/First Defiance Financial Corp., Mahoning Valley Regional President Frank Hierro offers as an example the idea of a salesman selling snow shovels.

“You have to buy them in August before selling them in November, December, January and February. Then you pay down the line [of credit],” he says. “You have to understand how cash flows through your business to understand how to use your line of credit to be more efficient and ultimately more profitable.”

To determine the cap on a line of credit – the maximum amount a business can borrow – banks look at a company’s overall financial performance, from sales to payable cycles to total assets. Typically, the cap is a function of sales, says Farmers National Bank’s eastern regional president, Tim Shaffer.

“If you have $1 million in sales revenue a year, you don’t need a $3 million line of credit. What’s appropriate? What’s your cycle? What are your 30- or 60- or 90-day cash needs?” he says. “How long is the cash you spend on inventory – that’s then converted to receivables – converted back to cash?”

For larger lines of credit, some financial institutions put restrictions on how much can be taken out of the line at a time. That figure is based on receivables and inventory, Shaffer says, offering a hypothetical 80% cap for receivables and 50% for inventory.

“If you have a $50,000 line, we’re probably not going to make you stick to that. But if it’s a $750,000 line, then it’s a good discussion to make sure the line is being used as it’s intended,” he says.

As intended, lines of credit are meant to be a form of short-term lending. Problems can arise when larger capital expenses such as equipment, real estate or even operating losses are put on them, says Stan Feret, chief lending officer at Cortland Bank.

“It’s never meant to be used for long-term expenditures or long-term real estate. It’s meant to be revolving,” he says. “When lines aren’t revolving, there’s usually two things happening. You’re not turning those short-term assets to pay the line down and/or you’re in a substantial growth mode. If you keep increasing levels and inventories keep going up, your current line of credit may not be sufficient to finance a larger revenue stream.”

If a business is given a $1 million line of credit, for example, but taps it for $400,000 worth of equipment and operating expenses, then that line really has only $600,000 in credit available. And should the time come when a business needs to pull $700,000 from its line of credit, it comes up short.

“Over time, if a business loses money, that money has to come from somewhere. It usually ends up on a line of credit. That should, at some point, be taken off the line and termed out,” Shaffer says. “Keep the availability for the short term.”

Like any other commercial lending product, a line of credit is “another arrow in the quiver” for businesses to use, says Peter Asimakopolous, vice president of small-business banking at First National Bank. “It’s part of everything we package together. It doesn’t necessarily operate on its own. There are some companies that only need their line,” he says. “They have enough cash or assets or operate in an industry where there’s not a lot of term debt required.” 

First National Bank sees about 40% use of its lines of credit, Colella adds, noting that while companies are still using their lines, strong performances in 2018 and 2019 mean many are liquid and don’t need to tap in as often.

Still, each business is different. Even within the same industry sector, businesses can be set up and operate in different ways.

“Some use it very little and for some, it’s used on a more continual basis. It all depends on how they’re structured,” says Brett Carnahan, vice president and commercial lending manager at 717 Credit Union. “There’s no industry standard for anybody. It’s all about how their finances dictate.”