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What is a Working Capital Line of Credit?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 02 December 2016
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A working capital line of credit is a financial tool that allows a business to easily borrow money for day to day operational costs when and as needed. A business with this type of credit option is assigned a specific limit, and may borrow up to that amount at any given time. The repayment terms are usually more liberal than with business loans, and provide the debtor company with more control in managing the settling of any outstanding balance. Companies are likely to use a working capital line of credit as a means of covering essential expenses in the short-term, paying off the balance as income from various sources is received.

There are several advantages to a working capital line of credit that set it apart from other financing options. Unlike a loan where interest is assessed immediately on the entire balance extended, a company with a business line of credit only pays interest on the current balance as of the day of the billing period where interest is applied. This means that a company could conceivably draw on the credit line the day after, use those funds to manage currently due bills, then pay off that amount before interest is calculated for the next billing period. Using this strategy, a business can reuse the line of credit over and over without incurring much in the way of interest charges.

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When there is a need to do so, companies can also stretch out the repayment of that outstanding balance for several months, and possibly even for years. While a minimum payment is due each billing period, the business may determine an amount above and beyond that minimum that will be paid each month, effectively reducing the amount of time it takes to retire the balance. In the interim, each payment frees a portion of the credit line, providing the business with at least some sort of financial backup if there is currently not enough cash on hand to settle a currently due obligation.

As with all financial tools, it is important to utilize the working capital line of credit responsibly. Doing so helps to improve the credit standing of the company, and may also pave the way for periodic increases in the total credit limit. Lenders typically review credit line accounts from time to time, and also evaluate the current financial circumstances of the debtor. As long as the company remains relatively stable financially, does not overdraft the credit line, and is paying off the balance from time to time, there is a good chance that the lender will at least continue to provide the current credit limit. Should the lender find reason to be concerned about the ability of the company to effectively manage the working capital line of credit, the limit may be reduced, or the credit line discontinued altogether.

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