Credit line: advantages and disadvantages

 

A credit policy is a short-term financing alternative that financial institutions make available to the client with an agreed limit and during a certain time, in which the funds will be used according to need.

There are different modalities within the credit accounts. In this case we are going to analyze the credit lines as well as the advantages and disadvantages of having one for the company.

Definition of a line of credit

Definition of a line of credit

A line of credit is an operation that is materialized through a policy formalized before a notary, through which the financial entity undertakes to make available to the client, a certain amount of money during a pre-established term, which usually ranges between six months and one year
Its operation is commonly reminiscent of that of a checking account, since all the money is deposited in the account at all times, and the balance decreases as it is withdrawn.

The main difference and to take into account, is that this balance does not belong to the client but to the bank. This means that during the period of validity of the line of credit, the client will be able to have the funds as many times as he needs without exceeding the established limit, but when the time of expiration arrives, everything extracted must be replaced in order to regularize the situation and possibly extend another year the enjoyment of the policy.

Advantages for the company of a line of credit

Advantages for the company of a line of credit

  • Flexibility

This is perhaps the most advantageous feature of having a credit line. During the term of the policy the client can make as many provisions as he considers (provided that he does not exceed the limit), of different amounts depending on the need of each moment.

  • Immediacy

Access to money is immediate, since it is deposited in a credit account in the name of the company, this avoids waiting times allowing the correct functionality of the organization.

  • Comfort

Because its operation is similar to that of a current account, a large part of the companies use it to finance current working capital expenses, such as payroll payments, unforeseen machinery repairs, payment to suppliers or any liquidity circumstance that may arise.

Possible disadvantages of a credit line

Possible disadvantages of a credit line

The main drawbacks of the credit line are the associated expenses, which are usually higher than other financing methods. Let’s analyze the main …

  • Non-availability expenses

Although in a line of credit the financial institution provides the client with a certain balance, he may decide not to use it in its entirety. In this way, the logic would be to pay certain commissions depending on the amount used, however, the reality is different. Most banks also apply a series of expenses for non-provision, this means having to pay also for what has not been needed.

Although it may seem unfair, the bank’s policy considers that regardless of its use, they have made a certain amount of funds available to the client immediately, and this implies a cost.

  • Formalization expenses

Unlike a current account that is signed in the entity itself, credit lines usually require formalization before a notary public. This is undoubtedly an extra expense.

  • Opening commission

This expense exists, since it is a way of financing for the company. A percentage is usually applied over the total limit available.

  • Interest on the provisions and exceeded

In the case of interest applied to the provisions, it is usually an average of the balance used.

The interest exceeded, occurs when the liquidity needs of the client exceed the limit set in the policy. It is usually higher than the interest provided since it is equivalent to the delay costs.

In any case, most companies appreciate having a credit line on their balance sheet, understood as a very useful tool, which ensures the maintenance of the company’s normal activity. The key is to act with caution and be clear about the causes for what should and should not be used.

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