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In the modern business world, one's credit rating is all-important. Having the capital available to fund everything from payroll to building projects is synonymous with success. Many business borrowers have shown a distinct preference for high credit limits at a disadvantageous rate over smaller limits which limit access to necessary funds. While this may seem counterintuitive, consider what a boon a high credit limit can be in a time of recession or even depression. When work becomes harder to come by, a higher credit rating can mean the difference between success and failure for a business of any size. More information on Factoring Receivables and Asset Based Lending
Why Go High?
Unlike private credit consumers, who are demonstrating a marked decline in the use of credit cards and lines as a fallback, business borrowers are moving the opposite direction. These borrowers leverage their assets to ensure they can access the funds they require to keep their employees paid, the doors open, and the lights on. These business borrowers are gambling that long term payoffs will far offset the short term cost of the higher credit lines they have available, and many of the world's most successful companies have used this seemingly backward logic to weather the economic storms of the last five years
A company with a higher credit line and a higher borrowing ratio can be assumed to be more stable and therefore more likely to pay off the loan than a company with a low interest, small cap line of credit or bank loan. This makes higher credit lines more attractive, even at a higher overhead than a smaller credit line, because investors and outside interests can and do consider a company's assets when determining whether or not to invest or contract a company for a given project.
What Are The Benefits?
In addition to accessing ready capital for applications like bills and payroll, having a consistently high credit rating makes a company more attractive to investors and partners. Many companies aren't eligible for government contracts such as highway building, supplier contracts for the Department of Defense, and so forth because they don't have the capital available for the high bonds such contracts require. By demonstrating a high credit rating, even at a higher cost, this opens the door for these companies to bid and gain these high-overhead, large-payout contracts where many of their competitors lack the resources to do so.
Because of this, having a higher credit limit can assure a business's success by allowing them to retain more, and more highly trained and qualified, individuals to cover the needs of the contract. This in turn generates more work, hence more capital. While a fair percentage of this capital may be tied up in paying off debts accrued during leaner periods, a larger business with a higher credit rating will be better positioned to take advantage of high-paying contracts and create a more successful base for their business.
A high credit to high interest ratio is a logical consideration for companies whose bottom lines depend heavily on being able to access large amounts of funds on short notice, such as for performance bonds, sureties, and so on. In such a paradigm, even a twenty-nine percent interest rate may seem to be a justifiable expenditure when measured against the devastating costs of losing one huge contract. In these cases, the company is using their reputation and credit rating to generate revenue. The high interest can be seen as an investment to assure future work and contracts in such scenarios.
What Are The Risks?
While for many business borrowers a high credit line at a high interest rate is a winning proposition, many small and medium businesses have attempted the same thing and found themselves out of business overnight. This class of business borrowers often agrees to higher interest rates for expansion of their merchandise or storefronts, such as boutique clothiers with three stores in one town and nowhere else. The trouble with small and midsize businesses leveraging high credit limits is that they often tie their personal finances, such as their home mortgages and personal savings, into the business as assets to appear more profitable on paper.
So long as the company continues to show a profit, this isn't an issue. The loan or capital credit is repaid, everyone walks away a winner, and the business principals can then realize even larger lines of credit. However, if the company fails to turn a profit, the interest on those credit lines continues to accrue to a rate ruinous to small and medium sized businesses. This can quickly result in downsizing, termination of personnel, and even the loss of homes, vehicles, and a person's life savings.
This, in turn, makes higher credit ratings even more expensive as creditors default and file for chapter eleven or chapter thirteen bankruptcy. Because a higher credit line carries with it greater inherent risks for the issuing bank or party, the percentage rates are considered to be commensurate with the risk the issuing bank is assuming. These higher costs are frequently passed on to consumers in the form of higher prices on everything from constructing a house to buying groceries at the local supermarket.
Which Is Right For My Business?
Defaulting on any type of loan or credit arrangement is a bad sign for personal borrowers and business borrowers alike. The first thing to consider when choosing a high credit line at a higher rate versus a lower credit line or small-cap loan is whether or not a business really need the higher line of credit. While having a high credit limit can make a business more attractive, many potential investors are now skeptical of a company with a high-rate credit line. In the past five years, there have been a number of businesses whose credit looked great on paper, but when the notes were called in the companies were unable to pay.
Advice on how to choose the right credit bracket for a given circumstance varies widely, but a sound "off the cuff" rule is to start by listing out available assets and finances. If Company XYZ has sufficient funds in its accounts to assure uninterrupted operations for six months if a loan or credit line is called due, a higher-rate credit line may be a worthwhile investment. If Company ABC does not have adequate funds or assets to leverage in the same scenario, a lower credit line might prove to be a wiser decision. In either event, reading and fully understanding the obligations, limitations, and other fine print of a credit agreement is absolutely essential to understanding one's rights and obligations under the agreement.
Retrenchment with available assets to cover any outstanding debts is far different than retrenchment when one's business is already underwater. For this reason, a business with a greater amount of available assets is a better and more secure risk for lenders than a smaller business with minimal funds and a profit margin that barely covers overhead. Of course, neither assures security. A savvy small or midsize business owner with minimal assets may prove to be a better credit risk over time than their larger competitor who has greater assets to draw from as collateral but has a track record of higher and costlier business risks.
Ultimately, business owners overall prefer the security of having a higher credit line to be able to draw from if necessary to the lesser risk of small-cap loans and low cost, low limit credit lines. The reasons for this vary from business to business and from year to year, as markets fluctuate and the needs and desires of consumers change to take into account new market realities. For these owners, the risk is generally considered to be offset by the profit to be gained from being able to tap a high credit line and get large amounts of money quickly rather than having to wait for payments to clear their banks.
Like any other business decision, choosing which lines of credit or loan options are best for a given business should be considered diligently. All the pertinent disclaimers and limitations should be studied, analyzed, compared, and contrasted against known factors and potential variables. A high rate, high credit line may not be the perfect solution for every business or every contingency. However, high credit limits do afford a certain level of prestige and extra consideration, making them an option well worth exploring further.
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