I often see catering businesses challenged with how to balance operational needs with financial ability. Increased staffing, kitchen modifications, asset investments introduce tricky growth decisions. Financing these growing pains with a line of credit is something that business owners often consider. But, that may not be your best solution. When is it right to use of line of credit?
What a line of credit is for
A line of credit is best used as a seasonal crutch and not for any long-term investments. For example, a retail store that needs to purchase $100k in inventory knowing that they’ll sell it all for $250k may use a line of credit to make that short-term investment that has an immediate return on investment.
With events, you may see this if you need to make a huge purchase of goods in anticipation of client payment later on in the season. Maybe you need to make a deposit in anticipation of an event, or place an order ahead of time. The best line of credit investment is when you have a quick turnaround (typically no more than a year) on the repayment of that debt.
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When a line of credit doesn’t make sense
A line of credit doesn’t make sense when a business uses it as a band-aid for a bigger financial problem. This happens when I see catering companies use a line of credit to cover an ongoing payroll issue or to pay the rent several times through the year. When you’re constantly dipping into the line of credit to cover ongoing costs and expenses, then your financial model is not secure. You’re spending money that you don’t have.
Sometimes the line of credit is used to make a big investment, like kitchen equipment, without a strong strategy for repayment. Ideally, you want to have a repayment plan, and you want to have it linked to a larger benefit for the company. For example, if you invest $20k in equipment, how does that help you produce more, sell more, and profit more?
Often, with a weak financial model where the line of credit is used as a band-aid, or when there is a larger investment without a strong repayment plan, the line of credit become a big balance that never gets paid off. And, that big balance sits collecting interest for a long period of time. This can also happen when financing business purchases with a credit card, which can have a similar impact on a business.
Alternatives to the line of credit
If you find yourself with this large credit balance and want to get out of the cycle of feast or famine, there are a few things you need to do:
- Create a cash flow plan. Chart out a forecast for how your money will flow in and out over the next year. Look to see where the valleys are, and grab control of your finances.
- Create more margin for your business. As part of your cash flow plan, you’ll want to think about how to create more profit for your business so that you aren’t relying on debt. If you are relying on debt constantly, your business is not earning enough.
- Consider converting your line of credit to installment loan. You may be able to secure a lower interest rate, and you’ll have a plan to repay the debt over a structured period of time. You need to see an end to this obligation or it will be your business’s albatross.
A line of credit can be beneficial in growing your business. But, before taking on that risk, make sure you’ve thought about the long-term impact of that decision, your repayment strategy, and the cash flow plan behind it.
