Management and Office Best Practices
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SECTION 6 OF 6
Line of credit can benefit many contractors, but avoid pitfalls
A line of credit allows a contractor to borrow funds as needed to fund working capital. This is especially critical for contractors who work in the commercial and industrial settings, when materials and labor have to be paid for the job but the contractor may not get paid by the customer for 30, 60, or 90 days in the future.
The line of credit allows the contractor to get money from the bank, up to a predetermined amount at a given interest rate, without having to apply for a new loan every time the contractor needs money.
Interest rates on lines of credit typically run close to what interest rates are on short term loans.
One of the pitfalls that contractors fall into is getting to the point where they need money from the bank and they don’t have the line already set up. Getting a line of credit set up generally takes a month or two and approvals have to come from the bank in advance.
Once the line is in place, using the line is usually pretty easy. Contractors typically don’t have to pay interest on the line of credit unless they are actually using it.
A contractor who thinks they may need a line of credit to finance work should set up the line in advance, to avoid needing it but not having it.
Another pitfall for contractors is using the line to fund things that aren’t cash generating. For instance, if a contractor wants to pay out bonuses at the end of the year or rebuild the office, the line of credit probably shouldn’t be used.
A line of credit usually has a requirement to pay it off completely once a year. In the case of the bonuses, they generally shouldn’t be paid if the contractor isn’t in a good financial position in the first place. If they are paid from the line of credit and the contractor doesn’t make enough in the future to pay off the balance, the line of credit can go into default and must be rolled into a loan.
In the case of rebuilding or buying a building, a contractor typically would get a long term loan instead of a line of credit because realistically, most contractors won’t pay off a building in a year or less.