Credit Lines: Peace of Mind for Your Business
Among the most basic types of credit used by any racquet sports business is the line-of-credit or revolving loan. Probably the shortest short-term financing offered by banks, a line-of-credit is just that, a loan agreement with the paperwork and approval process already complete. Many retail shops and tennis facilities rely on a line-of-credit or revolving loan arrangements to help bridge the inevitable slow periods or cash shortfalls.
A recent study conducted by the General Accountability Office, Congress’s watchdog, recently discovered that banks have promised to make over $1 trillion in credit available to businesses. Although the GAO’s study found that banks may not always properly account for those commitments, no evidence was discovered to indicate that banks systematically underpriced these arrangements. Unfortunately, fees for line-of-credit and revolving credit arrangements may soon increase as the effects of an international banking accord kick-in.
A line of credit
A line of credit is an agreement between a commercial bank and a business that states the amount of unsecured, short-term credit that the bank will make available to the business should it need it. A line of credit is not a guaranteed loan. It typically represents a one-year agreement that if the bank has enough available funds, it will allow the tennis business to borrow the maximum stated amount of money.
A line-of-credit arrangement helps speed the borrowing process for all concerned because the bank does not have to examine the creditworthiness of the tennis business each time it borrows money. Similarly, a revolving credit agreement is simply a guaranteed line of credit. The bank guarantees that the amount shown on the credit agreement will be available to the business. For guaranteeing availability, the bank usually charges a commitment fee, which applies to the unused balance of the revolving credit agreement. Interest is charged for the periods between when the funds are drawn upon and when they are repaid.
According to many experts, the most useful type of loan for many small retail shops is the line-of-credit loan. In fact, it’s probably the one permanent loan arrangement every racquet sports business should have with its banker, since it protects the borrower from emergencies and stalled cash-flow. Call it a line-of-credit, a revolving credit arrangement, check guarantees, or whatever, line-of-credit loans are intended for purchases of inventory and payment of operating costs, for working capital and business cycle needs. These loans are not intended for purchases of equipment or real estate.
A line-of-credit loan is a short-term loan that extends the cash available in the tennis business’s checking account to the upper limit of the loan contract. Every bank has its own method of funding, but essentially, an amount is transferred to the operation’s checking account to cover checks. The business pays interest on the actual amount advanced until it is paid back.
In many cases, line-of-credit loans carry the lowest interest rate that a bank offers since they are viewed as fairly low-risk. Some banks include a clause that gives them the right to cancel the loan if they think a business is in jeopardy. Interest payments are made monthly and the principal amount is paid off at the business’s convenience.
Banks often refer to these loans as a revolving line of credit. A number of experts feel that it is prudent to make payments on the principal often. They see these accounts and the re-payments as an indication that the retail shop or tennis facility is earning income.
Many line-of-credit loans are written for periods of one-year and are usually renewed almost automatically for an annual fee. Some banks require that the operation’s credit line be fully paid off for between seven and 30 days each contract year.
It’s difficult to put a value on the peace of mind that having funds available whenever they are needed can bring. So, too, is it difficult to put a price on the flexibility having a line-of-credit loan in place can bring. Unfortunately, an international banking accord may soon have a noticeable impact on the fees charged for line-of-credit loans and other financial transactions by many banks.
For years, banking regulations allowed banks — even enouraged them — to offer short-term credit facilities such as so-called “364-day lines.” Because banks were not required to maintain capital reserves against these less-than-one-year loans, they were frequently offered at extremely attractive rates. In fact, many banks use them as loss leaders to attract new customers, and many small business owners depend on them as economical, readily-available standby credit.
Unfortunately, thanks to the adoption of a new international banking accord called Basel II, and its requirement that banks must start setting aside capital against these short-term loans in 2007, the glory days of this short-term financing may be limited. Experts warn that small businesses should think about the consequences now, because banks may seek to pass on costs through the “increased expenses” clauses that most loan agreements contain.
There is increasing evidence that in some cases — particularly if you happen to be a small or mid-size business or your credit rating is either non-existent or has seen better days — the bottom-line for Basel II could amount to tighter credit and higher rates.
Here in the U.S., banking regulators have decided to apply Basel II on a mandatory basis only to the country’s largest, internationally-active banks. When all is said and done, it is estimated that only the 20 largest U.S. banks will switch to the new system. This leaves many banks to use current capital requirements.
Quite apart from the impact on the cost to borrowers, Basel II will also alter the way that the cost of capital is calculated for virtually every kind of risk encountered by a bank, including operational risks such as fraud, and consumer risks such as mortgage, credit card, and personal lending. For some banks, this will impact on their ability to lend. Every retailer and facility operator should be aware of this and negotiate with Basel II in mind. Or, perhaps, find a bank that has chosen not to comply with Basel II.
With major banks either on the verge of restricting or compelled to increase the cost of line-of-credit arrangements, many tennis businesses are turning to community banks. According to the Independent Bankers Association of America, in fact, in today’s banking climate it is often easier to get start-up loans and other basic short-term financing from community banks.
That’s not to say that financing is easier at a community bank. Your business will still have to meet the same credit and collateral requirements demanded by larger banks. Community banks, however, can be more flexible and are more apt to make so-called “character loans,” where the banker already knows the owner and/or the business.
Not all banks will have the same level of fees, so it may pay to shop around. Even if no line-of-credit loan is needed immediately, it is often wise to talk to a banker about how to obtain one now. Usually, to negotiate a credit line, a banker will ask for current financial statements, the operation’s latest tax returns, and a projected cash-flow statement.
With a line-of-credit loan in place, you’ll discover just how little it costs for peace of mind.
See all articles by Mark E. Battersby
About the Author
Mark E. Battersby is a tax advisor and author in Ardmore, Pa.