Equipment Line of Credit
An equipment line of credit may be the flexible funding solution your business needs. Small business financing is changing, that’s no secret. But as bank loans become a less used source of outside funding, it begs the question, what is replacing them? There are many, many answers to this ranging from short term merchant cash advances to business credit cards. One option stands out, and that is a line of credit. Business owners seeking revolving or flexible cash flow for their machinery and appliances find themselves researching an equipment line of credit.
There are two ways to interpret an equipment line of credit. One way is to think of it as a line of credit used towards equipment purchases, and that equipment creates a greater return to pay off the money borrowed plus interest. Another way to interpret equipment line of credit is as an asset-based line of credit on equipment. The funder provides money with collateral on the equipment and would seize it if payments are not returned. This option is more common if the borrower does not have strong enough credit or revenue to get funded without collateral, or if rates would be lower were collateral included.
When it comes to understanding how an equipment line of credit can work for your business’s cash flow, merchants must first understand the basics and varieties of lines of credit.
What Is A Line Of Credit?
A line of credit can be best understood like a credit card, only on a much larger scale for businesses. A line of credit has a maximum limit that can be spent, but is revolving as the account owner pays off amounts and spends more while not overreaching the limit. Most lenders will allow an increase credit limit request should cash flow needs prove warranted and reliable.
Lines of credit vary by lender in terms of interest rates, credit limits, minimum payments and occasionally uses or other reasons. Sometimes the money is in the form of a credit card or debit card, other times checks, virtual bank accounts or other means. This funding program also varies in terms of secured or unsecured, meaning there may or may not be collateral used as security for the lender. Unsecured lines of credit will typically have higher rates due to the increased risk of the lender potentially not getting their money returned.
Line Of Credit Compared To A Loan
As the two most popular means of financing equipment purchases, many business owners find themselves debating between an equipment line of credit and an equipment purchase loan. The two options are very different and it essentially comes down to your business’s long term cash flow needs.
A line of credit desired for its flexibility. There is a max credit limit but not a set amount; a borrower can continue spending as long as they pay off enough to stay within their limit. Merchants also do not have to use all of what they are given and will only pay interest on what they spend. This is great for businesses who have unpredictable cash flow needs and like to have a working capital source on hand just in case an opportunity, growth, unexpected setback or other event occurs. By utilizing flexible spending, borrowers can tailor how much they pay each month to their budget or cash flow. They can repay the entire outstanding balance all at once or just make the minimum monthly payments.
Bank loans, also known as installment loans or closed-end credit accounts, only provide a set amount of money with equal monthly repayment installments until the loan is paid off. Once a bank loan has been paid off in full, business owners cannot spend the funds again unless they apply for a new loan. This would be desired by a merchants who only needs working capital for a specific project and knows the optional funds would just sit idle, which can incur fees and penalties for lack of use depending on the funder’s terms.
Term Lengths of Lines of Credit
Not all equipment line of credit will have the same parameters. Your business may have a preferred term to work with, or it may only qualify for one length term depending on its financial situation. The length of the term is not always referring to the length of time the line of credit is available to you, which can be anywhere from one year to five, usually. The term length categorizes the credit line into the qualifications and deal parameters given based on where the merchant is financially, similarly to how a loan is decided. For example…
Short term line of credit
A short term line of credit may be for a short amount of time, yes. But what this refers to is similar to a short term loan. This would be given to merchants with poor credit, low revenue, or immediate needs. But the speed and risk comes at a cost, this option will have higher rates and potentially lower amounts.
Medium term line of credit
Just like merchants who qualify for medium term loans, this option applies to that same group. More stable business owners would qualify for this option which entails lower rates and larger amounts than a short term line of credit. These line of credit loan types scale with the size of your business and should have a max limit set as to not over leverage your business.
Bank line of credit
Banks are sought for their favorable terms and rates, but with 4 out of every 5 business owner who applies for a bank loan getting rejected, it can be tough for many merchants to qualify. This option is for the highest performing businesses. It is best applied for when revenue is robust to get these rates and terms and the line of credit will be there when you need it on a rainy day.
Types of Lines of Credit
An equipment line of credit is not the only way to finance your business. There are other programs that use no collateral, other assets, or due invoices. While a revolving source of cash flow may be what your business needs to run smoothly, you can maximize the benefits you get from this program by finding line of credit that taps into your best suited profit source.
Standard Line of Credit
For an in depth analysis, you can read our specific line of credit page. But for the sake of comparing standard to the variations listed below, a standard line of credit is a separate account opened, typically unsecured with no collateral. The money used is repaid with interest from the business bank account, which acquires profits from any source.
Equipment Line of Credit
An equipment line of credit is asset based. A lender of funder is betting that the new equipment they helped financing will help you generate higher revenue to pay them back with interest and then continue to raise the overall profits of your company afterwards, If you default while paying back, the funder is entitled to seize the machinery to recoup their losses.
Invoice Line of Credit
Invoiced backed lines of credit use your accounts receivable as collateral to establish a line of credit loan. This option is popular for merchants who often find their cash flow tied up due to other vendors and clients being late on payments. Rather than skip payroll or other expenses, client payments on those invoices go directly to a bank account managed by the lender and pay off your line of credit debts. If there are no debts, the money goes to your business. Either way, your working capital is freed up and you can have stable cash flow projections. Have extra invoices coming in? Your maximum credit might increase with it!
Inventory Line of Credit
This loan variety is especially helpful if your cash gets all tied up in recurring inventory purchases. Similar to an equipment line of credit, this asset based lending is tied to inventory that will create a greater return than what was spent to purchase it. If your business defaults on payments, the remaining inventory would go to the lender or funder to recoup their losses.
Business Credit Card
A common question business owners ask is what is the difference between a business credit card and an equipment line of credit. While they are similar in their revolving use, it essentially comes down to amounts and rates. Revolving loans are bigger than a credit card, some limits go to $50 million which is necessary for major purchases. Credit lines are typically set up for 1-5 years while credit cards are indefinite. With a long term cash flow source, merchants save time applying every time a project or need arises. The money is there when you need it, and you only pay when you do.
Lines of credit are good to have on hand when you need instant access to flexible spending. But beware of overspending recklessly. An equipment line of credit can go from a cushion for younger businesses to a bolster for older businesses taking on bigger projects, but you should always calculate your returns before spending any future money. An open line of credit can invite overspending, leading to an inability to make payments.
Details On Obtaining An Equipment Line Of Credit
Secured and Unsecured
Any type of line of credit can be secured or unsecured. For an equipment line of credit, that would be secured because the funding is attached to the asset. While it may sound intimidating to lose your assets if payment defaults, secured or collateralized loans will typically have lower rates and higher maximum limits because collateral lessens the risk for the lender.
Equipment lines of credit can be applied to leasing equipment, not just purchasing. Some business owners prefer to lease for cash flow purposes, but also for tax deductions. Leases are tax deductible as an operating expense under section 179. A leaseback can also be done, where a vendor sells an item and leases it back from the purchaser. This is common with commercial aircraft financing where massive purchases leave both sides looking for the best cash flow situation for their businesses.
When asking for a specific amount to fund your equipment, soft costs are eligible to be covered.
This includes highly customized modifications, installation services, freight and shipping, additional software, employee training and engineering fees. Other soft costs are also eligible, just as your lender.
In summary, here is a breakdown of the major pros of an equipment line of credit:
● Flexible cash flow ready when you need it
● May or may not have commitment to only spend on one predetermined asset
● Usually 1-5 years, can be extended
● Max credit limit designed for your cash flow, can be extended
● Investing into specific item to create a greater profit
● Obtain business critical equipment instantly
● Create an opportunity for cost saving economies of scale with larger operations