Contractors have unique cash flow needs, and they need flexible financing that can put money in their hands when they need it. Unexpected needs to purchase inventory, equipment, and supplies, coupled with the fact that they often face an irregular payment schedule from customers can lead to liquidity problems. This is where a business line of credit (bloc) can be critical for both contractors and small construction companies for completing projects on time
WHAT IS A LINE OF CREDIT?
A line of credit is similar in concept to a business credit card in that it provides a predetermined amount of cash for a borrower to draw upon whenever they need it and for whatever reason they need it for. The borrower only pays interest on the amount borhttps://kapitus.com/resource-center/what-is-the-difference-between-business-line-of-credit-and-business-credit-card/rowed, and there are conditions on how the borrower can spend that money. Borrowers typically draw upon a line of credit to meet short-term cash needs.
Much like a credit card, the interest charged on a bloc is variable – it is usually the prime rate plus a few percentage points. Borrowers can also choose between a secured and unsecured bloc, as each offers certain advantages. Unlike a credit card, however, blocs typically require borrowers to pay down some or all of the debt at various intervals.
One of the biggest benefits of a bloc is flexibility. Contractors often have irregular cash flows and unexpected costs that can cause a project to be delayed or go over budget. Having cash on hand to meet the needs of a project can go a long way towards successfully completing a project and earning you the reputation of being a dependable contractor.
HOW DOES A LINE OF CREDIT MAKE SENSE FOR CONTRACTORS?
Construction projects can involve spending millions of dollars to get started, with payment not guaranteed until the project is completed. Profit margins within the construction businesses are surprisingly small. The average profit margin for commercial projects is just 6%, accoridng to data compiled by Pro Est, a firm specializing in construction estimates.
These thin profit margins are the precise reason why having available cash through a line of credit is so crucial for contractors. Some of the most common use cases for contractor lines of credit include:
- Purchasing Inventory – With rising inflation and the supply chain shortage still hampering US businesses, making sure you have the inventory when you need it is more critical than ever to complete a project. A bloc allows you to quickly purchase inventory when you need it to ensure that your project is completed on time.
- Hiring Employees/Subcontractors – Whether you want to expand your business or take on a subcontractor for a one-time job, hiring is expensive. Lines of credit can enable you to cover payroll until you get paid.
- Purchasing and Maintaining Equipment – Owning and maintaining your own equipment is a powerful method of preserving your cash flow by avoiding high rental costs. Alternatively, you may use a line of credit to lease or purchase specialized equipment for one-time jobs.
- Cover Your Overhead – Overhead costs such as meeting payroll can immediately be funded with a line of credit.
Business Loan vs. Line of Credit
Some contractorS may ask: “If I need money, why not just take out a term loan? After all, they offer a fixed rate, so wouldn’t they offer better protection in a rising interest rate environment?”
The answer is that comparing a term loan to a line of credit is an apples-to-oranges comparison, as they are two different financing products that are usually used for different reasons. A term loan is generally used for long-term expansion plans, while a bloc is typically used to cover short-term cash flow needs such as unexpected expenses. While it is true that a bloc does charge a varying interest rate, it can be advantageous over a term loan for its flexibility.
Kapitus, does offer both financing products but it is important to note the distinct differences between the two:
|Business Loan||Line of Credit|
|Loan Term||Six months to five years||Up to 12 months|
|Repayment||Repayments begin immediately||Repay only when you borrow|
|Interest Charges||Charged upon disbursement||Charged only when you borrow|
|Use Case||Specific investments||Short-term financial needs|
Neither is strictly better than the other. It’s not uncommon for contractors to use both business loans and lines of credit for different purposes.
Unsecured or Secured Line of Credit?
Secured and unsecured lines of credit both have distinct advantages and disadvantages that contractors need to consider before choosing between the two. A secured line of credit means your borrowing will be secured against specific assets, such as equipment, cash reserves or real estate.
Unsecured lines of credit require no collateral and are the preferred financial products for most contractors However, secured blocs generally offer better rates and make it easier to get approved if you’re a new business or have a poor credit score. Here are the pros and cons of both:
Pros of Unsecured Line of Credit
- No collateral required
- Less risky for your business
- Additional flexibility
- Get approved with a lower credit score
- Lower interest rates
Cons of Unsecured Line of Credit
- Higher credit scores required
- Higher borrowing limits
- Strict underwriting process
- You could lose your assets
Generally speaking, lenders will consider your FICO score, time in business, operational capacity, cash flow and ability to provide collateral in order to approve you for a line of credit.
Streamlined loan application processing means applications are typically approved using automated systems. The first aspect of your application a lender will examine is your credit score. While getting a business line of credit with a poor credit score is possible, you’ll need to contend with higher interest rates.
Some lenders may also cordon off higher credit line amounts for the exclusive use of contractors with a higher business credit score. Newly incorporated contractors may have the option of using their personal credit scores instead to apply for a line of credit for their businesses.
If you’re struggling to obtain a line of credit, you may want to opt for a secured option. Secured options require real estate, equipment, or heavy machinery as collateral, but lenders will usually look more favourably upon your application.
At Kapitus, we provide lines of credit with a minimum credit score of 650, proof of at least two years in business, and average annual revenue of $180,000. To date, we have funded 64,000 businesses to the tune of $3 billion.
VISIT KAPITUS TODAY
The construction industry is a highly competitive landscape, meaning the business with adequate funding usually lasts longer than the business struggling to cover its expenses.
At Kapitus, we have worked with thousands of contractors in the past to provide them with customised lines of credit that are best to meet their specific needs. We offer quick, easy access to financing to give you breathing space when you need it most. Confront any unexpected expense and tackle multiple construction projects at once with the revolving credit you can use anytime you need it. If you want to learn more about how lines of credit work or how to apply for one, contact the Kapitus team today.