In an ever-competitive market, smart financing is one important lever to flourish. One potent tool that may be underutilized is a line of credit. Today, I show how restaurant owners can judiciously use a line of credit (LOC) to fuel their growth journey. Before I dive deep, let’s take a moment to understand what exactly a line of credit is.
What is a Line of Credit?
A line of credit is a flexible loan from a bank or financial institution that allows you to draw funds up to a specified limit and only pay interest on the amount borrowed. It’s like a loan that’s already approved and ready only when you need it, granting you a pool of funds that you can tap into as needed.
Advantages/Disadvantages of a Line of Credit?
The biggest advantage of a LOC is it’s flexibility. You only draw on it when your business needs the extra cash, and you can usually pay the full amount owed back in full, without any early payback penalty. The biggest disadvantage is the short term nature of the LOC means potentially higher interest rates compared to a more traditional, longer term loan
Another advantage is having the piece of mind that working capital is available if you need it. The foresight to have that substantial buffer can be a lifesaver. For new locations especially, having three to six months worth of expenses on hand as working capital can cushion you against unexpected downturns. Similarly, maintaining a reserve of 2-3 months for existing outlets (based on location profitability and your risk tolerance), may be additional security against market volatility.
When Should a Restaurant Owner Utilize a Line of Credit?
Some answers: when expanding to a new location or fortifying your existing operations. The beauty of the LOC, especially in a market with higher than normal interest rates, is that you can secure the line but not use the credit until it is needed. Additionally, depending on the type of LOC, you can easily pivot intented uses. So, for instance, if your plans to expand have been put on hold, you can keep the LOC unused and not incur interest.
How to Apply for a Line of Credit?
Applying for a LOC typically involves the following steps:
- Research: Start with thorough research to identify lenders offering the best terms.
- Prepare Your Documents: Have your latest business financial statements (and possibly future projections) and tax returns ready.
- Consult a Financial Advisor: To steer clear of pitfalls, seeking advice from a financial expert (like Strata Cloud Accountants) can be invaluable.
- Application: Submit your application through the lender’s platform or per lender instructions.
Determining the Right Amount to Apply For
Deciding on the amount to apply for hinges on various factors, including the scale of your expansion and the financial health of your existing outlets. Here’s a simple guide:
- New Locations: Aim for a line of credit that supplements the goal of having at least 3 months of working capital to safeguard your venture as it finds its footing.
- Existing Locations: A line that supplements 2-3 months of working capital, adjusted based on profitability and your risk tolerance.
A line of credit offers the much-needed financial buoyancy to navigate the stormy seas of both existing operations and expansion. By strategically utilizing this tool, you can build a more realistic self-financing path and reap all the rewards of your success.