What is a business line of credit and how does it work?

If your business needs a flexible way to access funds, a line of credit may be a good option. A business line of credit can help you manage changes in cash flow, handle seasonal fluctuations in sales and cover unexpected costs—all while supporting growth. 

Here are some key facts about business lines of credit—and how to determine whether one is right for your organization.

What you’ll learn:

• A business line of credit provides a revolving credit line you can draw from repeatedly as needed, paying interest only on the amount you borrow from what’s available.

• You can use a line of credit to help manage cash flow, cover operating expenses and support short-term growth for your business.

• A business term loan differs from a line of credit in that the funds are delivered in a lump sum and repaid over a fixed term, with different interest charges and fees—and a different repayment term.

• To determine if you qualify for a business line of credit, lenders consider factors such as creditworthiness, revenue and years in business.

Much like a business credit card, a business line of credit is a form of revolving credit that allows you to access funds for company purchases as needed. You can borrow up to your approved credit limit, and your available credit is replenished as you repay what you’ve borrowed. 

A business line of credit is different from a traditional business loan, which provides a lump sum you repay over time with interest. 

Business credit lines may be secured or unsecured. If secured, you’ll be required to provide collateral—such as cash, inventory or real estate—to back the loan. This may make approval easier or lead to better terms than an unsecured business credit line could offer. Unsecured lines of credit don’t require collateral, but you’ll typically need good to excellent credit to get approved.

Business lines of credit work by providing a flexible way to access money that your company can draw from as needed. Although it depends on the lender, you can typically access funds through your business checking account via bank transfer, check or a debit card linked to your account. 

After a lender approves your business for a credit line, it sets the credit limit—the maximum amount you can borrow. You can draw from the line of credit during a set period of time, often known as the draw period, which can range anywhere from one to five years. This, too, depends on the lender.

You’ll pay interest only on the amount you borrow from your credit line. As you make payments, your available credit replenishes and you can borrow again up to your credit limit. Just keep in mind that repayment terms vary by lender.

Businesses typically use a line of credit for short-term funding needs, such as:

• Managing cash flow: A business line of credit can support cash flow management by covering gaps between when your expenses are due and when revenue comes in.

• Covering operational expenses: During seasonal slowdowns, a business line of credit can help provide support to keep your company up and running.

• Purchasing inventory or supplies: Keep your inventory and supplies stocked up before your busy season hits by accessing your business line of credit for these purchases.

• Handling unexpected costs: If equipment needs to be repaired or there’s a sudden spike in the price of materials, a business line of credit can provide quick access to funds that will cover these unexpected costs.

• Supporting short-term growth: Use your business line of credit to cover the costs of hiring contractors or fulfilling spikes in demand, helping you take advantage of opportunities that support your growth.

There are a few key differences between business lines of credit and traditional business term loans, including:

• How funds are received: A business loan provides a lump sum upfront, while a line of credit allows you to draw funds only when you need them. 

• Funding amounts: You may have access to more funds through a term loan, making it a better option for larger purchases or long-term investments that can help grow your business.

• Repayment terms: Repayment terms for business lines of credit vary by lender, but they’re often shorter—commonly ranging from one to five years. Term loans typically have longer repayment periods, which may be up to 10 years.

• Interest charges: For a term loan, you make fixed payments—which include interest—on the full loan amount. You’re charged interest only on the amount used with a business line of credit.

• Fees: You may encounter more fees with business lines of credit than with business loans. Common fees can include origination fees, annual fees or monthly maintenance fees.

Like any financial product, business lines of credit have both advantages and potential drawbacks to keep in mind. Here’s a closer look at the pros and cons of a line of credit to help you decide whether getting one makes sense for your business.

The key advantages of a business line of credit include:

• Flexible and quick access to funds: After your business is approved for a line of credit, you’ll typically have immediate access to funds. You can borrow the amount you need, when you need it, up to your credit limit.

• Enhanced cash flow management: A business line of credit can be a great way to bridge the gap between your expenses and revenue.

• No interest on unused funds: With a business line of credit, you pay interest only on the amount you use. 

• Opportunity to build business credit: If you use your line of credit responsibly—by taking actions like making on-time payments—and the lender reports the activity to the credit bureaus, a business line of credit may help build or strengthen your credit score.

The drawbacks of a business line of credit may include:

• Higher fees: Lenders may charge annual fees, maintenance fees, draw fees and other charges that can increase the overall cost of the line of credit. 

• Shorter repayment terms: You may need to repay the balance in a relatively short amount of time, which can make paying down larger balances more challenging.

• Risk of overborrowing: Because funds are easy to access, you may be tempted to draw from your line of credit more than needed, which can lead to overborrowing if it’s not managed correctly.

• Collateral or personal guarantee requirements: Some lines of credit may require collateral—like access to your business assets—or a personal guarantee to help reduce the lender’s risk.

• Changing credit limits: Lenders may lower your credit limit or freeze the line if you violate the terms or your business’s financial performance declines.

To get a business line of credit, you’ll submit an application—typically through a bank, online lender or credit union—that will determine your eligibility. While requirements vary by lender, factors often considered include:

• Your credit score: Lenders may review both your business and personal credit scores before approving you for a line of credit. While a higher score is preferred, you may still qualify based on other factors even if your scores are on the lower side.

• Your business revenue and cash flow: Lenders typically look for consistent cash flow and profitability to determine whether your business can repay what you borrow.

• Years in business: Many lenders prefer businesses with two to six years of operating history to demonstrate stability, though some lenders may accept less time in operation.

• Collateral: You may need to offer collateral to secure a business line of credit or qualify for a higher credit limit with better terms. 

If you’ve determined that a line of credit is right for your company and that you meet the requirements, the next step is to thoughtfully compare lenders. You can start with your current financial institution, but other options include online lenders and fintech platforms. 

Next, you’ll gather the necessary documents—which may include bank statements, tax returns, your balance sheet and your profit and loss statement—and review the terms carefully. Before applying, be sure you understand the interest rate, fees, repayment terms and whether collateral is required.

A business line of credit can be a valuable tool for managing short-term needs by offering flexible access to funds. Whether you’re navigating cash flow gaps, covering unexpected expenses, or supporting seasonal or growth-related demands, understanding how lines of credit work—and how they compare with other financing options—can help you make a more informed decision about what’s right for your business.

You might also consider a business credit card from Capital One. Along with access to a revolving line of credit, you may be able to earn rewards, receive a welcome bonus and qualify for a low introductory APR. You can even get pre-approved today—with no impact to your credit scores.