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How much credit does your business need?
Work with your banker to calculate how much your credit line should be.
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Is there a good rule of thumb for knowing how large a line of credit I need to be successful?
There is a rule of thumb. Now the rule of thumb depends slightly by region and by industry. But we can quantify within a reasonable range the amount of money that we’ll get on a working capital line of credit. For example, we can take our receivables, good receivables, meaning receivables that are less than 61 days old, and we can multiply that times a number, say 70 percent, approximately. That’s a good rule of thumb. We can also look at our inventory. There are certaintypes of inventory that bankers will lend money on. Now those range, those rates range maybe from 30 percent, 40 percent, maybe sometimes even 50. So we can talk to our banker and ask them, “Do you like this inventory, will you lend on it?” And with those calculations we can come up with a pretty close range on the line of credit that we’ll be able to get from the bank.
Now the question is how large a line of credit can I get, but the following question I would ask is, do you want it to be as big a line of credit as possible or is that not a smart strategy?
Well, if I could respond to that. What we want to do on a line of credit when we talk to the bank we want to be able to calculate what we need today, but more importantly we want to make sure that we have an adequate line of credit for the next six months or a year. There’s nothing worse than going to a bank and having them go through all the due diligence, approve a loan today and then the sales grow so rapidly that we run out of our line of credit six months from now.
I would really agree with the advice Jerry is giving. I think you do need to have some room for growth in the company. The caution I would heed though, is not to put a number out to the banker that’s extremely high hoping that they might lower to a more reasonable amount, because if you go in with a request that’s not reasonable it’s going to cause red flags to some part of the bankers.
It has to be in line with some practical business application.
Absolutely. And not to go in with an amount that’s not big enough. That’s equally as dangerous because if you fully advance the line and you can’t meet your growth obligations that can be problematic as well.