Business can be unpredictable.
Revenue can fluctuate. Unexpected expenses can pop up, well, unexpectedly. Then, there are global emergencies and political and legal changes to consider.
Good finance teams always have a backup plan. Oftentimes, that involves access to an emergency credit line.
What is an emergency credit line?
An emergency credit line is a financial tool designed to give your business quick access to funds during unexpected situations.
While a regular credit line gives you open access to a limited fund of money to use as your business requires it, an emergency credit line is like a pre-approved loan, ready and waiting for you to access under certain circumstances.
Think of it as a safety net.
If you suddenly find yourself short on cash and unable to pay your expenses, you can draw on the emergency credit line.
Let’s explore why you might find yourself in that position.
The benefits of having an emergency credit line available
More options for managing cashflow
Emergency credit lines can be incredibly useful for managing unexpected expenses, such as when an employee spills their coffee on their MacBook, and you’ve got to buy a new one quickly.
It’s also an easy way to manage temporary cash flow gaps, like when you’ve got loan repayments due but a customer payment is delayed.
Keep your employees paid
Ensuring your employees receive their monthly salary is a top priority.
When cash stops flowing in — whether due to delayed payments, seasonal fluctuations, or unanticipated client contract cancellations — an emergency line of credit can be a great option to tap into and keep payroll running smoothly.
Seize on opportunities
It’s not all doom and gloom.
Emergency credit lines can also be a valuable tool for seizing on opportunities that pop up but that you couldn’t otherwise manage with your existing cash.
That might look like a purchase of additional machinery or equipment, the buyout of the stock of a competitor who is going out of business, or even doubling down on a marketing campaign that has traction but needs more resources thrown at it.
Manage seasonal fluctuations
Some businesses are simply subject to seasonal fluctuations, which can mean revenue drops significantly for an extended period while certain fixed costs — rent, for example — stay constant.
While its a best practice to put cash aside during on-season months in anticipation of this fluctuation, sometimes an off-season hits early or runs longer than expected, and an emergency credit can help businesses bridge the gap.
Prepare for unexpected crises
Try as we might, we can’t plan for everything.
It might be a somewhat tired example at this point, but the COVID pandemic was still a really poignant example of this.
Things happen that are outside of our control as business owners and financial leaders, and sometimes they have an outsized impact on cash flow.
Having access to an emergency credit line for crises like this ensures you can meet financial obligations and avoid getting into even hotter water.
Is an emergency credit line right for you?
Emergency credit lines can be a helpful financial tool.
They aren’t a “must-have” though, and there are a few other options for business financing that might be more appropriate depending on your needs.
Let’s explore three major options.
Emergency credit lines vs. business credit cards
The main difference between these two kinds of business credit cards is their purpose.
Credit cards are designed for regular spending, while an emergency line of credit is for unexpected expenses.
Credit lines generally have more flexible repayment terms, lower interest rates, and higher borrowing limits.
Business credit cards, on the other hand, may offer important rewards and perks like cash back and travel benefits.
Emergency credit lines vs. business loans
Traditional business loans provide you with a lump sum, which you’ll have to pay back in pre-defined installments.
An emergency credit line isn’t used until it's required, and you’ll only have to make repayments and pay interest if and when you actually use it.
Credit lines are more likely to have variable interest rates and negotiable repayment terms, whereas a traditional business loan generally has a fixed interest rate and structured repayment terms.
Emergency credit lines vs. trade credit
Trade credit involves an agreement between businesses and suppliers to delay payment for goods and services.
Essentially, you can order and receive goods now and pay later (in 30 days, for example).
Trade credit is generally interest-free, provided its paid within agreed terms, but it is also limited to specific purchases — most specifically those made with the vendor in question.
Emergency credit lines provide broader usage, but they do come with interest payments, increasing your overall cost of borrowing.
What’s involved in obtaining an emergency line of credit?
You obtain access to an emergency line of credit from a financial institution, usually your bank.
The exact process you’ll go through depends on the institution's exact requirements, as well as your history with them. For example, if you’re already banking with a given institution and have a credit history with them, the application process will likely be faster and require less paperwork.
You’ll first need to decide how much credit you need access to, then begin the application process.
That said, here’s a general guide to what will be involved in getting an emergency credit line:
- Eligibility check: The first step will be to fill out some forms and provide some basic information about your company, such as revenue and duration of operations. The bank will then run a basic check to make sure you’re eligible to apply according to their requirements.
- Credit check: The institution will check your business (and possibly personal) credit history.
- Additional documentation: In most cases, you’ll need to provide additional documents such as financial statements, banking records, and business licenses.
- Collateral: If you’re applying for a secured line of credit, then you’ll need to offer some form of collateral, which the lender will assess and approve.
- Approval: All things going well, you’ll be approved for the emergency line of credit.
- Negotiation and singing: Here’s where you get to negotiate terms such as how the funds will be made available when required, repayment terms, and any applicable interest rates or other lending fees. Once both parties are happy, you’ll sign the deal and have an emergency line of credit available.
Tips and best practices for using emergency credit lines
1. Make sure you’re aware of the risks involved
Before you apply for an emergency line of credit, beware that it's not all upside.
If you use your line of credit, you’ll have to meet repayment obligations, which often come with additional interest charges.
There’s also the psychological impact of having money at your disposal.
Since you know there’s an emergency fund there, you may be more inclined to make riskier business decisions or draw on it when, if you didn’t have the line of credit available, you would have come up with some other solution.
2. Set procedures in place to ensure it's only used in emergencies
You can reduce the risk that you draw on your emergency credit line unnecessarily by putting clear procedures and definitions in place as to when and how it can be used.
You might, for example, set a policy that funds can only be accessed in the case of large-scale external events (like a global pandemic) but that seasonal fluctuations must be handled by putting additional cash aside during high-earning months.
3. Ensure that you’ll have rapid access to the funds when needed
Make sure you ask about access to your emergency credit.
While the lending might be approved, there may be some hoops to jump through when it comes time to access it (such as updating documentation or seeking approval.
If there is truly an emergency, you might need access to funds within 24 hours. If that’s the case, make sure you confirm that it's possible, and get it in writing with your financial institution.
4. Work to negotiate more favorable terms with lenders
Part of keeping your cost of borrowing low is improving your lending terms.
If this is your first line of credit and you have little credit history with the bank you’re applying at, then you might have limited bargaining power.
Over time, though, as you prove your ability to repay any credit used on time, you’ll be better positioned to negotiate better repayment terms and drive that interest rate down.
Going beyond emergency credit lines
Emergency credit lines are a helpful financial tool for dealing with unexpected delays in payments for customers or capitalizing on urgent business opportunities.
Having access to additional funds to fuel growth and keep operations rolling is critical, as is effective oversight and visibility into spending behaviors to prevent emergencies in the first place.
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