What is a Line of Credit?
A commercial line of credit sometimes abbreviated to LOC is an agreement between a business and a bank (or other financial institution) to allow the business to utilize a bank facility (similar to a flexible loan or credit card) up to a maximum agreed value as and when they need it during a specified term.
The cost of a line of credit is the interest charged on the drawn down balance and usually a commitment fee based on the entire facility. Repayments are made to agreed terms, but there will normally be a minimum monthly amount to be repaid. A revolving line of credit is one which replenishes itself each time a repayment is made by the business.
Using a line of credit, the business is only charged interest on the used portion of the line of credit, but has the certainty that the facility is available if needed. This is distinct from a loan agreement in which the business will pay interest on the full amount of the loan.
Lines of credit have many uses, for example, a business might use a working capital line of credit, secured on accounts receivable or inventory, to allow for fluctuating day to day cash flow for purchasing inventory and growing the business.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.