Managing and Protecting Your Business Line of Credit

If you’d like to establish a line of credit for your small business, you might be wondering where to start. Usually, the answer is right in front of you: your current bank.

Most banks prefer to lend money to businesses that are already their customers. The reason is simple: the more of your business -- deposit and retirement accounts, merchant and cash-management services, personal bank accounts and services -- that a bank has, the more profitable your business is to the bank.

Banks call this “relationship banking,” and it’s a big factor in their assessment of credit requests. Since your current bank already has some knowledge of your business and your potential creditworthiness, it’s in a better position to gauge your credit application accurately and objectively -- and to work with you should you encounter any payment difficulties down the road.

Once you’ve been approved for a line of credit, there are measures you can take to keep the line open and flowing. Here are three of the most important.

1. Provide regular reporting. Your bank may want to see various reports on a regular basis (e.g., monthly or quarterly), including accounts-receivable aging schedules and inventory reports. If so, be diligent in providing these reports, and do it before your bank has to ask you for them. Failing to submit required reports or consistently submitting them late may indicate to your bank that you have something to hide or that you’re simply a poor manager.

2. Stay in compliance with loan covenants. Covenants usually take the form of financial ratios that the bank will monitor and want to see maintained at certain levels. They may include:

Debt to equity: The formula is total liabilities/equity. This ratio should generally be less than 3-to-1.
Debt-service coverage: The formula is net operating income/total debt service. This ratio should generally be 1-to-25 or higher.
Current ratio: The formula is current assets/current liabilities. This ratio should generally be 1-to-2 or higher.

Be sure you understand any required covenants before signing a loan agreement. Go over them with your certified public accountant if necessary, and don’t agree to any covenants that you may not be able to meet.

Keep lines of communication open. Banks hate surprises, so communicate early and often with your bank about anything going on at your business that could impact your ability to service your line of credit. The earlier you let your bank know about potential problems, the better it will be able to work with you to help resolve them. The same goes for good news. Share your company’s successes with your bank. This will help you in the future should you need to ask for an increase in your line of credit or need to apply for a different kind of business loan.

(Source: Don Sadler (AllBusiness.com a D&B Company))