Funds are the proverbial soul of any business enterprise. For smooth operation, business organizations are always looking to secure funds. However, in times of an emergency when a cash crunch becomes acute, it might force an entrepreneur to run to individuals or different financial institutions to get the required funds. To meet the emergency requirement and to help the company to tide over the crisis, financial institutions such as Banks and NBFCs offer a line of credit to the embattled organization.
The lines of credit ensure that the company has access to money – ‘on-demand’. Through the lines of credit facility, a company can avail the business loan immediately to the extent necessary up-to-the overall limit set for some time. It is necessary to underline that the company will pay the interest only on the money drawn from the maximum limit set for a specific period.
Once the borrowed amount is paid back, the company’s overall credit limit is restored, and it can borrow the money whenever required. Here, flexibility is the key; a company can access the funds when in need, pay back the amount in time, and can avail of the facility again.
How does the line of credit works?
Before elaborating on how the line of credit facility helps businesses, it is necessary to understand the options available for companies to raise funds. There are two broad ways for companies to raise funds:
- Lines of credit
These can be further categorized into:
|Secured funds||To avail of this facility, the lenders ask for collateral in terms of equipment, raw material, shares, property, equipment, etc.|
|Unsecured funds||The financial institution doesn’t need any collateral for giving funds.|
As mentioned above, there are two options available for companies to avail funds through loans or lines of credit. By applying for loans, a company gets a one-time lump-sum amount of money for business needs. The company is supposed to service the loan in a specified period on mutually agreed terms and conditions. The loan is generally paid in installments over some time.
By contrast, a line of credit ensures that the company has access to a fixed amount of money limit, and it can meet its immediate requirement through this fund. Line of credit facility is designed keeping the company’s business interest and strategies in mind. Moreover, it has to serve only for the amount of money that has been utilized or borrowed out of the total amount sanctioned. This is a fruitful method to meet the immediate fund requirement of companies during the cyclic phase of the business.
Line of Credit offers
Financial institutions offer lines of credit loans in two ways:
- A secured line of credit – When a secured loan is offered, institutions take assets of the company as a security. As the risk-reward ratio is in favour of banks, such secured loans are offered at a lower rate of interests on liberal terms. This is so because, in case of failure of the company to service the debt, financial institutions can recover the outstanding money by liquidating the assets available with the institutions.
- An unsecured line of credit – In an unsecured lines of credit, there are no assets available with financial institutions as security. There is greater risk involved in offering such credit to companies as the recoverable amount in any case of default is low.
Types of Line of credit
For money-seekers, the two most common types of line of credit available are:
- Business Line of credit
- A personal line of credit
Financial institutions providing a lines of credit facility set up the limit and other terms and conditions on the credit made available in both cases.
Line Of Credit – A Boon To Start-ups?
Most of the start-ups face an uncertain business environment for which they need a cushion of cash to navigate successfully. Line of credit facility is a wonderful opportunity for these companies to explore. Procuring necessary funds aids these wannabes to remain afloat during a crisis and utilize the funds as and when necessary.
Features of unsecured line of credit
There are three important features of lines of credit. These are:
1) No collateral: There is no collateral required for availing an unsecured line of credit. SMEs or companies in the service sector with little or no assets are the biggest beneficiary of this primary feature.
2) Quick disbursement: The amount is credited within a short period and with ease. It only requires a minimum amount of documents to get the company’s credit sanctioned.
3) High rate of interest: As there is no collateral involved as a security amount, financial institutions charge a higher rate of interest from companies.
Eligibility criteria for an unsecured line of credit
Financial institutions look for certain parameters before considering an application to an unsecured line of credit. Although the parameters vary and depend upon different institutions, some of them are:
- Business performance: Banks usually lend only to stable businesses with satisfactory performance. Good performance not only enhances a company’s chance of securing aline of credit, but also influences the amount of money to be sanctioned.
- Companies with three months of operation are the minimum criteria for availing the facility.
- The company’s turnover should be ₹ 90000 for 3 consecutive months before the date of application. Companies with 3-5 years of operation are preferred by financial institutions to sanction unsecured line of credit.
- Credit score – Financial institutions keep track of the company’s credit score. This shows how fast the company has serviced its past debts, the time taken, and default proceedings (if any). Higher the credit score of a company, greater the chance of availing the facility.
Documents required to obtain an unsecured line of credit
Some of the required documents to obtain an unsecured line of credit loan are:
- Business Registration Proof
- KYC-documents of both, the applicant and the organization
- Bank statement required for the last nine months of operations
- Promoter’s PAN Card
- Promoter’s Aadhaar Card
Benefits of Line of credit
- One of the major benefits of line of credit is lesser interest outgo for companies. Interest is levied only on the amount of money utilized by the company from the overall sanctioned amount.
- Companies don’t have to liquidate their assets in case of paucity of funds. The line of credit facility is beneficial to the SME sector.
- The process to avail credit facility is simple and easy.
Things to remember
Before agreeing with an availing line of credit, you should check:
- The rate of interest to be charged by the financial institutions.
- Other charges such as stamp duty, processing fees, foreclosure charges, penal charges, and repayment tenure.
- Understand the terms and conditions, and every minute detail of the agreement.
An unsecured line of credit facility is a big boon to the SME sector that doesn’t have ample liquidity to tide over cash crunch problems at times. Since most of these businesses are cyclical, they faced negative headwinds during the lean period. The unsecured line of credit provided by financial institutions ensures these companies are not short of funds and remain operational. This facility is also beneficial for companies that seek funds for expansion. Today Banks, NBFCs offer an unsecured line of credit to efficient and well-managed companies.