Operating credit is a flexible financing solution that many businesses use to manage day-to-day expenses and improve liquidity. This type of credit is particularly useful for businesses that experience seasonal variations in revenue or have irregular cash flows. In this article, we'll take a closer look at what operating credit is, how it works, the benefits of using it, and key factors businesses should consider before adopting such a credit solution.
What is operating credit?
Operating credit, also known as an overdraft or operating loan, is a line of credit that the bank makes available to a business. Unlike a regular loan, where the borrower receives the full amount of the loan immediately and starts paying interest on the entire sum, operating credit allows businesses to draw up to a pre-agreed amount as needed. Interest is only charged on the portion of the credit that is actually used.
How does it work?
When a company establishes an operating credit, a maximum credit limit is set up based on the company's financial situation and needs. The company can withdraw funds up to this limit at any time, and can then replenish up to the limit as they repay used credit. This provides great flexibility in the management of the company's liquid assets.
Benefits of operating credit
1. Flexibility: Operating credit allows businesses to manage financial fluctuations without having to take out a fixed business loan every time a temporary need for additional capital arises.
2. Improves liquidity: It helps businesses maintain a stable liquidity even during periods of variable earnings.
3. Pay only for what you use: Unlike traditional loans, where interest is paid on the entire loan amount, businesses with operating credit pay interest only on the portion of the credit that is in use.
Assessments before using operating credit
1. Costs: It is important to be aware of all the costs associated with operating credit, including interest rates, set-up fees and any annual maintenance fees.
2. Risk of overspending: While flexibility is a great benefit, it can also be tempting for businesses to become too reliant on their credit, which can lead to financial problems.
3. Collateral requirements: Some banks require collateral to offer operating credit, which may include real estate or other valuable assets.
Executive summary
Operating credit is a very useful tool for businesses that need flexible access to capital to manage current expenses and maintain good liquidity. By only paying interest on the amount actually used, businesses can effectively control their financing costs. However, it is important that businesses carefully assess their financial needs and risks before establishing such a credit facility. Used correctly, operating credit can be a crucial tool to support a company's operational needs and growth opportunities.
