A credit policy is a short-term financing alternative that financial institutions make available to the client with an agreed limit and during a certain time. You can use the funds according to need.
There are different modalities within the credit accounts. In this case, we are going to analyze the credit lines as well as the advantages of having one for the company.
Definition of a line of credit
A line of credit is an operation that is materialized through a policy formalized before a notary. Through a line of credit, the financial entity undertakes to make available to the client a certain amount of money during a pre-established term. It usually ranges between six months and one year.
The main difference is that this balance does not belong to the client but to the bank. This means that during the period of validity of the line of credit, the client will be able to have the funds as many times as he needs without exceeding the established limit. However, when the time of expiration arrives, everything extracted must be replaced in order to regularize the situation and possibly extend another year the enjoyment of the policy. If you want to do some calculations for your business, try this business line of credit calculator.
Advantages of a line of credit for the company
This is perhaps the most advantageous feature of having a credit line. During the term of the policy, the client can make as many provisions as he considers. Of course, it’s valid if he does not exceed the limit of different amounts depending on the need of each moment.
Access to money is immediate since it is deposited in a credit account in the name of the company. This avoids waiting times allowing the correct functioning of the organization.
Because its operation is similar to that of a checking account, a large part of the companies uses it to finance current working capital expenses, such as payroll payments, unforeseen machinery repairs, payment to suppliers or any liquidity circumstance that may arise.
Possible inconveniences of a credit line
The main drawbacks of the credit line are the associated expenses, which are usually higher than other financing methods. Let’s analyze the main.
Although in a line of credit, the financial institution provides the client with a certain balance, he may decide not to use it in its entirety. In this way, the logic would be to pay certain commissions depending on the amount used; however, the reality is different. Most banks also apply a series of expenses for non-provision; this means having to also pay for what has not been needed.
Although it may seem unfair, the bank’s policy considers that regardless of its use, they have made a certain amount of funds available to the client immediately. This implies a cost.
Unlike a current account that is signed in the entity itself, credit lines usually require formalization before a notary public. This is undoubtedly an extra expense.
This expense exists since it is a way of financing for the company. A percentage is usually applied over the total limit available.
Interest on the provisions
In the case of interest applied to the provisions, it is usually an average of the balance used.
The exceeded interest occurs when the liquidity needs of the client exceed the limit set in the policy. It is usually higher than the interest provided since it is equivalent to the delay costs.
In any case, most companies appreciate having a credit line on their balance sheet. It’s understood as a very useful tool, which ensures the maintenance of the company’s normal activity. The key is to act with caution and be clear about the causes of what should and should not be used.
The banks carry out a rating and set the interest rates for the loan depending on their credit rating. The credit line has an impact on creditworthiness. It is often used by banks. In this post, learn what a line of credit is and how it affects creditworthiness.
Mechanism for businesses
The credit line is the upper limit up to which a loan can be granted. The line of credit is also known as the credit line or credit limit. It is the maximum limit for a loan that is agreed between the borrower and the credit institution.
This line of credit depends on the borrower’s credit rating. The better the credit rating, the higher the credit line can be set. A decisive criterion for the credit line is the regular cash receipts on the checking account of self-employed and companies. If these incoming payments are high enough, a high credit line can be granted. This line of credit is critical to the overdraft facility granted by the bank to the checking account.
For self-employed and companies, this overdraft is referred to as a current account credit, while it is known to private individuals as a credit line. It is an agreed credit line. The credit line is the maximum amount that you can use in addition to your existing balance.
Agreed and tolerated line of credit
The credit line differentiates between the agreed and tolerated credit lines.
The agreed credit line is the normal overdraft facility that the bank grants for the checking account. This overdraft facility and its amount are contractually agreed upon. As a current account holder, you can overdraw your current account up to the amount of the agreed credit line.
In contrast to the agreed credit line, no credit line is contractually agreed for the tolerated credit line. The bank tolerates the overdraft of the checking account up to a certain limit. Companies and the self-employed should not overdraw the company loan for longer than three months.
Types of credit for lines of credit
A current account credit for the current account is a typical loan for entrepreneurs and the self-employed, for which a credit line is granted. The credit line marks the maximum amount up to which the current account credit can be drawn. A credit line can also be granted for guarantee credits. A guaranteed loan is a guarantee or guarantee given by a bank to the self-employed or to a company.
The bank does not pay out money, but it takes over a guarantee. Companies and the self-employed can avail themselves of such guarantee loans for various purposes. A line of credit can also be granted for Lombard loans, which are short-term financing and where securities or movable property serve as security.
A credit line is only set for current accounts.
A credit card is an exception. There is also a credit line here. It is the monthly budget. In contrast to the current account credit, there is usually no interest when using the credit line for the credit card.
Determining the amount of the credit line
There are no legal regulations for determining the credit line. The banks are free to decide on the amount of the credit line and are not obliged to grant a credit line. Banks use various calculation methods, but they rarely make them public. Incoming payments to your checking account play a crucial role in granting a line of credit. Because the earnings of self-employed and companies vary from month to month, some banks may have problems with a line of credit. Some banks require receipts of the same amount for a credit line.
The companies experiencing financial bottleneck because customers do not pay on time should contact their bank and seek the conversation. If various types of collateral can be proven, it is possible that a credit line will be granted.
The credit line as a revolving credit
The credit line is a so-called revolving credit. While an installment loan is mostly paid to a separate account and repaid in monthly installments, the credit line applies to the current checking account. It can be used as a revolver. This means that no application to the bank is required to use the credit line. If there is enough money in the checking account, the credit line can be repaid in the meantime in order to be used again afterward. The user of the credit line is not obliged to make regular repayments. This revolving loan must be repaid, but unlike the installment loan, there are no fixed agreements.
The borrower can determine how he wants to repay the revolving loan. However, repayment can affect the amount of the credit line. If the credit line is repaid late and only with small amounts, the bank can set the credit line lower.
The line of credit and the interaction with the credit rating
The credit line interacts with the credit rating. Companies with a good credit rating can receive a higher credit line than those with an unfavorable credit rating. The creditworthiness of the self-employed and companies depends on various factors. A good order situation, punctual incoming payments from customers, the punctual payment of credit installments, the quick payment of invoices and the use of cash discounts have a positive effect on creditworthiness. It can lead to a high credit line.
In the opposite case, the credit line can also affect creditworthiness. A high credit line speaks for a high credit rating, since the higher the income and sales of a company, the higher it is set.
The measure of creditworthiness – the credit line
The credit line is often used by banks to assess their creditworthiness. A high credit line indicates a good credit rating. Credit bureaus and banks derive high sales and high income for companies and self-employed from a high credit line. It does not matter whether the credit line is actually used.
Always keep an eye on your credit rating
In order to have good chances of granting a loan, it is important for companies and the self-employed always to pay attention to a good credit rating. A high credit line plays an important role in this. Learn more about the line of credit for businesses here.
Line of credit has great importance for businesses. If you want to know what your creditworthiness is like and how you can improve your creditworthiness, you should check your creditworthiness for free on bank score. If your data is incorrect, you can correct it there directly. If you need financing, you will receive an offer online that matches your credit rating. Our partners will be happy to help you with financing.