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Working capital and lines of credit

A line of credit exists for one reason: the money goes out before it comes in. You pay wages on the fifteenth and the invoice settles on day sixty. A facility that sits behind that gap costs interest only on what you draw, and the room comes back as you repay.

Typical size
$50,000 to $2,000,000
Typical time
Three to six weeks with a bank. Faster on a non bank facility.
Security
General security agreement

When it fits.

  • Payables that settle before receivables collect.
  • Seasonal inventory bought ahead of the season.
  • Payroll across a slow quarter in a business that is otherwise profitable.
  • A contract award that needs mobilisation cash before the first progress claim.

When it does not.

  • Funding a loss. A line of credit lends against a timing gap, not against a shortfall that repeats every month.
  • Buying a fixed asset. Equipment paid for from an operating line locks up the room you need for the cycle.
  • Replacing owner equity in a business that has never been capitalised.

The detail, if you want it.

Open only what applies to you. Nothing here is required reading before a first call.

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How it actually works

Two structures cover most of the market. A conventional operating line comes from a bank or credit union, is priced off prime, and is sized against cash flow and the strength of the balance sheet. It is the cheapest money you will find for this purpose and the slowest to arrange.

An asset based line is sized against a margined pool of accounts receivable and inventory, usually seventy five to eighty five percent of eligible receivables and a lower advance on inventory. The limit moves as the pool moves, which is what makes it work for a business growing faster than its retained earnings. It carries a monitoring burden the operating line does not: a borrowing base report, an ageing, and periodic field examination.

The choice between them is not about which is better. It is about whether the constraint is the balance sheet or the growth rate.

What a lender will ask for6
  • Two years of financial statements, and the current year to date
  • Two years of T2 returns
  • Accounts receivable and accounts payable ageing, current
  • Six months of business bank statements
  • A schedule of existing debt and any registered security
  • Inventory listing, where the facility is asset based
And what they will ask you4
  • What created the gap, and does it close by itself?
  • How concentrated is the receivable book, and who are the top five debtors?
  • What is the cash conversion cycle in days, and what moved it?
  • What triggers repayment, and what happens if that trigger slips a quarter?
Questions we get about this one3
Do I pay interest on the whole limit?
No. Interest accrues on the drawn balance. Most lenders also charge a standby fee on the undrawn portion, typically a fraction of a percent, and an annual review fee.
How is the limit actually set?
On a conventional line, from cash flow and the balance sheet, often expressed as a multiple of monthly sales or a percentage of margined receivables. On an asset based line, from a borrowing base you report monthly.
Will a line of credit affect my existing bank relationship?
It can. A new general security agreement ranks against the same assets your bank already holds. We map the existing registrations before anyone is approached, which is part of why we do not contact a lender until you have approved the list.
Read about this2

Is working capital the right instrument for your deal?

Tell us the amount and the timing, and we will say which instrument we would reach for.

No lender hears your name until you say so.

A request emailed to twenty lenders leaves twenty records. The next one to see it reads the declines before they read the deal, and a file that looks shopped is priced as one. So the list is built with you, approved by you in writing, and nothing leaves this office before that.

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