Line of credit

How a line of credit works

BDC describes a line of credit as a short-term, flexible loan that allows a business to borrow up to a preset amount. Interest accrues daily on what you have drawn, and monthly interest payments are required. You can repay some or all of the balance when cash allows, then borrow again up to the original limit.

Lenders often secure these facilities against accounts receivable and inventory. For larger lines, the amount available can move with those balances, while for small businesses the authorized amount often stays fixed from month to month. Lines are generally treated as demand loans, which means the lender can require repayment at any time. Read the agreement for the actual terms.

How it differs from a term loan

A term loan has scheduled payments over a set period and does not revolve. BDC contrasts it with a working capital term loan, which has a set interest rate and repayment period, while a line of credit is repaid and reused as cash flows in and out. The two solve different problems. A line suits timing gaps. A term loan suits a purchase that will pay back over years, and it is then recorded as long-term debt.

An illustrative example

Imagine a landscaping business with a $40,000 approved limit. These figures are illustrative only. In April it draws $15,000 to buy materials before customers have paid. Interest is charged only on that $15,000. In May, customer payments arrive and it repays $10,000, leaving $5,000 drawn and $35,000 available again. The danger is treating the facility as permanent money. If the balance never falls, the business may be financing losses or long-term assets with short-term, recallable credit. Your cash-flow records show whether the draws are temporary.

What to discuss with your accountant

Bring the credit agreement and monthly statements. Ask how the balance is shown on your financial statements, how to record interest charges separately from repayments, and whether the interest is deductible given what the borrowed money was used for. The CRA generally allows interest on money borrowed for business purposes, but not on borrowing for personal purposes.

Also ask which assets secure the line, what happens if the lender asks for repayment, and how a draw fits your cash forecast. Related reading includes working capital, long-term debt and why profitable businesses run short of cash.