A line of credit (LOC) is a pre-approved borrowing limit from a bank or lender. The business can draw funds up to the limit as needed, repay them, and draw again — like a credit card but typically at lower interest rates (7–18% variable for small businesses).
Interest is charged only on the amount drawn, not the full limit. A 10,000 drawn costs interest on $10,000. If the balance is repaid to zero, the interest cost is zero — but the credit remains available.
A line of credit is best understood as a financial safety net. Its primary use is bridging short-term cash flow gaps — covering payroll during a slow week, paying a supplier before a large accounts receivable payment arrives, or handling an unexpected expense without draining the cash reserve.
The critical rule: establish a line of credit before you need it. Banks evaluate creditworthiness based on financial strength. Applying during a cash crisis — when the balance sheet is weakest and the need is most desperate — is the worst time to qualify. Apply when the business is healthy, keep the line available, and draw on it only when the cash flow forecast shows a short-term gap. See Managing Cash Flow and Financing and Debt Management.