By Evan Carmichael on December 6th, 2011
Stan Prokop is the founder of 7 Park Avenue Financial. The firm specializes in business financing for Canadian companies in the areas of working capital, asset based lending, SR & ED tax credit financing, equipment financing, franchise financing and banking.
He’s also a Platinum author on my website – you can check out his articles here. I asked him 6 questions about lines of credit for entrepreneurs:
What is a business line of credit?
The common definition of a business line of credit is an approved credit facility that provides short term working capital for the Canadian business borrower. Business credit facilities can be secured or unsecured. They can also be collateralized against specific assets such as accounts receivable and inventory.
Business lines of credit are not long term debt obligations for your company – they are used to provide working capital and cash flow liquidity for day to day operations such as payrolls, inventory purchases, and fixed obligations such as rents, payroll, etc.
Which option would you recommend a bank line of credit or alternatives to a business operating line?
The necessity for a business credit facility arises out of your company’s need to carry working capital accounts, typically receivables and inventory. Banks in Canada lend on a combination of the business assets and general credit worthiness of the business, as well as the personal guarantees and credit histories of the owners of the firm.
We strongly recommend bank facilities to firms that can meet Canadian chartered bank business credit guidelines – typically those guidelines are: established firms, clean balance sheets, profitable, and positive cash flow.
As we can imagine thousands of firms who are still growing but have financial challenges in the 4 categories we noted above do not qualify for traditional bank lines. We then, as an example, work with clients to put alternative facilities in place. Those facilities include receivable financing, inventory financing, purchase order financing, or monetization of tax credits such as the SRED program. (Yes SRED R&D credits can be financed!) These types of facilities are non-bank in nature, are often combined in some sort of manner, and have less stringent borrowing and approval criteria.
Business credit facilities provide a cushion for the business owner – they allow liquidity while inventories are converted to receivables which are converted to cash.
How does a business owner know if their company needs a bank line of credit?
The classic symptoms are for recognition of a need for such a credit facility can be easily calculated by any business owner. By adding his days sales outstanding to his days inventory outstanding and then subtracting his days payable on hand the business owner can easily calculate one simple thing – how long it takes 1$ to flow through his or her firm . If that number, for example is 75 days, and you are required to pay your creditors in 30 days… well we think you get the picture! The bottom line is simply that if you are growing and have an investment in receivables, inventory, etc then you most definitely need a business credit facility.
Can you provide us some benefit of getting a line of credit for a business?
Business credit facilities provide a cushion for the business owner – they allow liquidity while inventories are converted to receivables which are converted to cash… with the cycle starting all over again. The ability to maintain relationships with key suppliers is critical for any firm. Business credit lines allow you to take advantage of supplier discounts and purchase smarter.
What are the drawbacks of getting a line of credit?
One of the drawbacks of a credit facility is that they can lull the business owner into a sense of false comfort. This allows A/R and inventory to build up. We caution clients that revolving business credit facilities must do that, revolve! If you are always at the top of a business credit line we would suggest some of your operating metrics are out of control. However if sales and profits are growing the usage of your facility might simply be reflecting that.
Would you recommend start-ups to apply for line of credit?
In Canada, in general start ups do not qualify for a business line of credit. We have touched on part of the reason on that already – i.e. not financial bench strength on the balance sheet, no track record, etc. Those businesses that do achieve business credit lines at start up are, quite frankly business facilities that are secured by personal holdings of the owners. That really isn’t a business line of credit! We would point out though that many start ups do qualify for alternative line of credit financing.
Tags: asset based lending, bank business, banks in canada, business assets, business borrower, business financing, business line, business lines, capital accounts, credit histories, credit worthiness, debt obligations, equipment financing, financial challenges, inventory purchases, personal guarantees, positive cash flow, prokop, receivable financing, work with clients