Understanding Business Bank Lines of Credit in Canada | 7 Park Avenue Financial

 

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The Business Owner's Guide to Credit Lines in Canada 

 

In today's competitive business landscape, securing adequate financing is paramount to the success and growth of any enterprise

 

Access the capital your business needs, even if you've faced rejection from traditional lenders in the past. Learn how to turn your financing struggles into opportunities for business growth

 

 

Introduction 

 

For every complaint, you hear about Canadian business-to-business financing and our chartered banks (trust us, we hear a few!) there are still some great things happening in commercial business banking in Canada.

 

Let's examine bank lines of credit and your need for such a facility to grow your sales and profits.

 

Recent studies reveal that over 60% of small businesses in Canada have never accessed a line of credit, potentially missing out on key growth opportunities and financial flexibility!!

 

Let the 7 Park Avenue Financial team demystify the concept of demand loans and General Security Agreements, and unveil the key factors that influence the calculation of your line of credit as well as the nuances of inventory financing, shedding light on a topic that often leaves business owners perplexed.

 

We'll also lift the veil on the security measures banks employ and the symbiotic relationship between business owners and banks, emphasizing the importance of cultivating strong partnerships that can unlock the full potential of your bank line of credit for the growth and prosperity of your firm.

 

  

Understanding Canadian Business Lines of Credit  

 

Canadian businesses use operating lines of credit to finance current assets. Typically, those asset categories are predominantly accounts receivable and inventory.

 

So how do banks facilitate this borrowing arrangement? The typical manner in which this is done is to simply have a document executed that provides the bank with a conditional assignment of accounts receivable, your inventories, and any other current assets.

 

 

Demand Loans and General Security Agreements

 

 

Canadian bank operating facilities are also called demand loans because they are typically secured by another document called a GSA, which stands for General Security Agreement. This document, as you can imagine, allows the bank to 'call' your firm's loan at any time. It's just common sense that Canadian banks do never with to 'call' those loans, it's simply their protection if and when things go awry.

 

  

Annual Renewal  

 

Clients are sometimes under the mistaken impression that bank lines of credit are good for an indefinite amount of time. Typically, however, they are renewed annually for the credit limit  - which requires a review of financials and business bank account performance  by your account manager.

 

 

Calculating Lines of Credit

 

If there is one other very common question asked by clients, it revolves around how exactly the banks calculate lines of credit.

 

The formula is not as complicated as you think! A typical business-to-business financing on a Canadian chartered bank line of credit margins your accounts receivable at 75% or their value. It's critical here to note that the bank uses 90 days as a measurement tool - no receivables over 90 days can be margined, or in effect 'borrowed against'.

 

Why is that? Again, common sense prevails, in that the bank, (and us too by the way!) assumes that the receivables over 90 days are uncollectible to a certain extent. Your firm might think differently, but that’s how it’s done.

 

 

Inventory Financing Challenges

 

Inventory. Wow! What a different kettle of fish this is! If we had to generalize, but be as specific as we can be for info purposes we can say that in general banks wrestle with inventory financing.

 

Margining and inventory percentages are very different based on your industry, as well as the composition of your inventory. (Inventory typically comes in three categories: raw materials, work in process, and finished goods).

 

Typical bank financing of inventory usually never exceeds 50% and at the same time usually has a cap on the facility, meaning that even if your inventory is growing it still might be subject to a maximum of financeability.

 

The takeaway here?  Banks aren’t in the inventory business, these assets are much harder to liquidate than receivables, and rarely does a lender ' win ' in an inventory liquidation!

 

 Security and Notification 

 

So let’s get back to the security the bank takes on bank lines of credit. Do your clients find out about this? In Canada, they would normally never be notified unless there is a default by your firm on the line of credit facility. In that case, your clients would receive a notification of the assignment, in which the bank would direct your clients to pay them directly, reducing the loan of course.

 

Banks register their security with the appropriate provincial and federal authorities, further protecting their position.

 

 

High-Risk Industries: Specialized information for businesses in high-risk sectors (like hospitality or construction) and how they can secure and manage credit lines.

 

 

1. Businesses in high-risk industries often face unique challenges such as fluctuating market demands, higher operational costs, and regulatory hurdles. For instance, the hospitality industry is sensitive to economic cycles and consumer preferences, while construction projects often have long timelines with variable costs. An in-depth analysis of these risk factors is crucial in tailoring credit strategies.

2. Securing Credit Lines: Banks and financial institutions may be hesitant to extend credit lines to high-risk industries due to perceived volatility. Businesses in these sectors need to present robust financial planning and risk mitigation strategies. This includes detailed business plans, cash flow projections, and perhaps even offering collateral to increase their creditworthiness.

3. Negotiating Terms with Lenders: Given the higher risk around credit approval, these industries might face less favourable borrowing terms. Businesses need to negotiate terms, such as interest rates, owner personal guarantee, repayment schedules, business credit cards, and covenants, that align with their operational realities and online banking needs. Building a strong relationship with lenders and demonstrating a track record of responsible credit use can aid in this process.

4. Effective Use of Credit Lines: Businesses should strategically use credit lines for managing cash flow, particularly during off-peak seasons or when awaiting payment for big projects. It’s crucial to avoid overleveraging and to use the funds for growth-focused investments or essential operational expenses.

5. Risk Management Strategies: Implementing robust risk management strategies is key. This could involve diversifying the client base, adopting cost-control measures, and staying adaptable to industry changes. Regularly reviewing and adjusting these strategies can help in maintaining financial stability.

6. Monitoring and Reporting: Regular financial monitoring and transparent reporting are essential. This includes keeping detailed records of how the credit line is used and its impact on the business’s financial health. Regular communication with lenders about the business’s performance and any potential risks can also help maintain a good relationship.

 

 

  

  

Key Takeaways    

 

 

1. Credit Evaluation: Banks assess a business's creditworthiness before extending a line of credit. This process involves reviewing financial statements, credit history, and cash flow projections. Understanding this evaluation is crucial, as it determines both eligibility and credit limits.

2. Interest Rates: The cost of borrowing is dictated by interest rates, which vary based on the Bank of Canada's rate and the borrower's creditworthiness. Comprehending how these rates are applied to the borrowed amount helps in estimating the cost of the credit line.

3. Repayment Terms: These define the conditions under which borrowed funds must be repaid. Terms include minimum monthly payments, which often consist of interest plus a portion of the principal. Grasping these terms is essential for managing the debt effectively.

4. Secured vs. Unsecured Lines: Secured lines require collateral, like real estate, while unsecured lines do not. Each type has different risk levels and interest rates. Knowledge of these differences aids in selecting the most suitable option for a business.

5. Usage Flexibility: Lines of credit offer flexibility, allowing businesses to borrow as needed up to a set limit. This adaptability makes them ideal for managing cash flow, particularly in covering short-term expenses or capitalizing on opportunities.

 

  

Conclusion  

 

There is a great tendency in Canada to 'blame' our conservative banks for limiting lending possibilities for commercial business-to-business financing. (We love our banks by the way).

 

Consider the reality though, that we entrust them to protect our savings and deposits, and it's Canadian business owners and financial managers that run their businesses into problems.

 

Clients are encouraged to maintain solid relations and seek out great commercial business bankers. (Not all are great, unfortunately).

 

If you're looking for a banking facility that works, call  7 Park Avenue Financial,  a trusted, credible and experienced Canadian business financing advisor for business advice,  who can help you maximize growth through smart business financing solutions  with assistance in evaluating the risks and benefits of different financing options

 

 

 FAQ: FREQUENTLY ASKED QUESTIONS /  PEOPLE ALSO ASK  / MORE INFORMATION 

 

What are business lines of credit?

Business lines of credit are flexible loan options for businesses and assist in small business loan challenges in today's market, allowing companies to borrow up to a certain limit and pay interest only on the amount used. Fluctuations in the account will automatically pay down the facility via cash inflows from collections, etc.




How can a business line of credit benefit my business?

It offers financial flexibility, allowing you to manage cash flow, fund short-term needs, and capitalize on business opportunities without taking a large loan - ie maximizing effective strategies for securing business loans for funding growth and day-to-day operations




What's the difference between a secured and unsecured business line of credit?

Secured lines require collateral like real estate, offering lower interest rates. Unsecured lines, while more accessible, typically have higher rates.




How do interest rates work with business lines of credit?

 

Interest rates are variable and depend on your creditworthiness and the Bank of Canada's rate. You pay interest only on the amount borrowed.




What should I consider before applying for a business line of credit?

Assess your financial health, understand the repayment terms, and consider the interest rates and potential fees associated with the credit application.



Is it challenging to qualify for a business line of credit in Canada?

Qualification depends on your business's credit history, financial health, and sometimes collateral. A strong credit profile increases approval chances. Alternative financing options for struggling businesses are also available in the alternative financing landscape - There are creative funding sources for entrepreneurs in non-bank lending in Canada that provide a valuable tool for SME funding needs.




Can startups apply for business lines of credit?

Yes, startups can apply, but they might face stricter scrutiny due to their financial health -Business financing solutions for startups and SMEs are more available in the alternative lending landscape via factoring, short term working capital loans, etc.




Are there any fees associated with business credit lines?

Yes, some banks charge application, annual, or usage fees. It's important to review all potential fees before applying.




How quickly can I access funds from a business line of credit?

Once approved, you can typically access funds quickly, often within a few business days, making it suitable for urgent financial needs.





What factors influence the interest rate on a business line of credit?

Interest rates are influenced by the Bank of Canada's rate, market conditions, your business's creditworthiness, and a bank or commercial non-bank lender's policies. The  net worth of the business owner and  personal financial investments and credit score are also factors.



How does a business line of credit differ from a term loan?

Unlike a term loan with a fixed amount and repayment schedule, a small business line of credit offers flexibility to borrow as needed up to a set limit.



Can I use a business line of credit for any type of business expense?

Generally, yes. It's designed for a range of business purposes, including inventory, equipment, and managing business cash flow fluctuations.