Most SMBs will use one or both of two major financing sources, but which is better, the business line of credit vs the business credit card? From time to time, small businesses can face urgent cash needs. A supplier invoice may need to be repaid, a repair in a key facility may need to be completed, or an electricity bill may need to be paid on time to avoid late fees. These are just some examples of the types of costs and potential cash outflows that a small business owner encounters. For these uses and more, having access to multiple financing options that can easily be tapped is essential.

Both financing options come with their own merits, but that doesn’t necessarily mean that they can be used interchangeably. In some scenarios, it is better to use the business credit card while other scenarios may call for drawing on the line of credit. In this article, we go over both options to outline the best practices for ongoing utilization.

What is a Business Line of Credit?

A business line of credit (LOC) is often called a ‘revolving credit facility.’ At the establishment of the loan contract, the lender will set a predefined limit for the LOC that the borrower can borrow up to. The borrower is not obligated to draw on the line of credit, and has the option to only draw down the amount that they require.

When the borrower draws on the LOC, the LOC’s credit limit goes down by the amount of the withdrawal. The borrower can then opt to pay all or a portion of the drawn funds back, and the LOC’s limit is replenished in the same amount of the repayment. 

To provide clarity on this structure, picture a LOC with a defined credit limit of $10,000. If a borrower opts to draw down $3,000, the remaining limit on the LOC is now $7,000 ($10,000 $3,000 = $7,000). Subsequently, the borrower then repays $1,500 of the $3,000 drawn down. Now, the new limit on the LOC is $8,500 ($7,000 + $1,500 = $8,500). 

Benefits of a Business LOC

There are several advantages to using a business line of credit:

1. Sizable credit limit

One of the upsides of a business line of credit is the ability to have access to a large sum of cash quickly when needed. Depending on the size of your company, your relationship with your lender and your business credit history, you can secure lines of credit with limits of up to $100,000, or even more.  

2. Flexibility

The business LOC enables you to draw down and pay interest only on what you need rather than giving you a lump sum amount and charging you interest on the whole amount. This flexibility makes the LOC a valuable standby option for many SMB owners to use selectively as required. 

3. Cost-effective

The interest rate on a business line of credit will usually be tied to the prime rate. As such, the bank will quote you the prime rate plus a specific percentage when offering the interest rate. In most cases, this rate is substantially cheaper than the rate that most credit cards charge.

4. Fees

Business lines of credit generally don’t come with any ancillary fees besides fees on late payments. If ancillary fees are charged though, the most common ones are related to the annual maintenance of the loan (under $100 per year in most cases) or an origination fee paid when the application is processed.

Depending on the lender though, you may also have to pay other fees such as a ‘draw fee’ paid every time you make a withdrawal. To avoid being caught by surprise, it is best to discuss with your lender and read the loan document carefully before signing.

5. Cover expenses that can’t be paid with credit cards

There are some expenses that you cannot pay with a credit card. For example, if you lease your property from a landlord, you are asked to pay by cheque or cash in most cases. Similarly, some vendors also do not accept business or personal credit cards. For these expenses, drawdowns can be made on the LOC to fulfil key obligations.

What is a Business Credit Card?

In many ways, a business credit card is remarkably similar to your personal credit card. The lender provides you with a physical card that can be swiped at the Point of Sale (POS) or whose details can be entered online to facilitate payment. Like the business LOC, the business credit card comes with a set limit as well.

As a business, you can spend up to that amount through the course of the month without needing to repay anything. The credit card usually comes with an interest-free grace period, which means any payments made within this grace period are charged zero interest. However, if the card is not paid in full during this grace period, you will still have to make a minimum payment and interest will be charged on the remaining balance. 

Besides the steep interest rates on credit cards, usually in the double digits, one thing to be mindful of when using a business credit card is its fee structure. Most business credit cards will charge an annual fee that varies from lender to lender depending on the type and tier of the card. In addition, lenders will also charge fees for spending over the limit and making late payments. These costs can add up quickly, so it is best to understand them prior to obtaining the card.

Benefits of a Business Credit Card

There are several advantages to using a business credit card:

1. Minimum payments

Most credit cards have a requirement for borrowers to make a minimum repayment while the remaining balance can be paid at a later date. This flexibility can potentially be useful for certain types of businesses rather than having to make a full payment each month.

2. Multiple users

Business credit cards can be issued individually to multiple users within the same company. In this way, employees are empowered to make necessary purchases as needed, and the issue of an employee paying out of pocket to get reimbursed by the business later is avoided entirely. 

3. Rewards

Unlike a business line of credit, a business credit card can reward your spending. For each dollar spent on a business credit card, the business can earn rewards such as Airmiles, Aeroplan points, other travel perks or even simple cash back. Over time, these rewards can be cashed in to save money down the road. For example, a business where employees have to travel significantly can accumulate Air Miles and cash them in later for free airline tickets.

4. Promotions

Some lenders will often have introductory promotions for new joiners of their business credit card program. During this introductory period, you can potentially capitalize on benefits such as zero APR, higher points earned for rewards, lower thresholds for rewards, etc.

Despite these advantages though, the main point of consideration with a business credit card is the high-interest rate. Business credit cards can often have APRs up to 23% or even higher, and this poses a danger of your business being trapped in a debt cycle if you don’t apply prudent financial management practices. It is best to only charge what you can reasonably afford to pay back within a month or two on your credit card, and ideally during the interest-free grace period.

When to Use a Business Line of Credit

A business line of credit is best used in certain distinct circumstances:

1. Seasonal businesses

If you own a business that goes through seasonality every year, a business line of credit is a better tool to use than a credit card. When a business experiences seasonality, there is often a lack of sustained cash flow during off-peak seasons due to limited revenues coming in.

In these situations, a line of credit is helpful as most LOCs only require a minimum payment to be made each month, and charge a lower rate of interest than a credit card. Businesses can simply ensure they make the minimum payment on time and thus save on highly expensive interest costs on the business credit card.

2. Paying for expenses that cannot be charged on a card

As noted above, there are certain expenses such as rent or leases that a business cannot swipe a credit card for. Some vendors may also refuse to accept credit cards for purchases of inventory. For these expenses, the line of credit can come in handy if the business doesn’t have the cash on hand immediately. 

3. Paying for large purchases

Credit cards normally come with a smaller limit than a business line of credit. For purchases that cannot fit within this limit, the business line of credit can be an alternate financing tool to complete the transaction.

It should be noted though that the size of the credit limit on a LOC is contingent on your business credit history and size. If you have an established, mature business that generates stable cash flows each year, you are more likely to obtain a line of credit with a higher limit.

When to Use a Business Credit Card

A business credit card is useful in the following scenarios:

1. When you want to build your business credit 

Just like your personal credit history, a strong business credit history can enable you to obtain favourable financing terms from lenders at a later stage. Typically, a line of credit is provided to businesses that are at least semi-established and have a reasonable operating history. A business credit card can, therefore, be used to build up a credit history to obtain a business line of credit or a lump sum loan later down the line.

2. When you make everyday purchases that you want to track

A significant benefit of using a business credit card is that it enables you to see all of your transactions (such as travel & entertainment, office supplies, etc.) in a single view and apply appropriate filters to categorize different expense categories. This is an especially useful feature for reporting and taxation purposes at the end of the year.

3. When you need quick financing

While a business line of credit can take longer to set up, most credit card decisions can be made in less than a day, making them ideal for situations where you need financing on a time-sensitive basis.

FAQs About a Business Line of Credit vs Business Credit Card

How do you get a business line of credit in Canada?

A business LOC often has eligibility requirements that can vary from lender to lender. Approach your preferred lender(s) and ask them what their requirements are. If you meet the requirements, then start preparing documentation including your recent financial and banking statements, tax returns, personal credit history, business incorporation/license papers, proof of a bank account, and any other mandatory items that the lender would need to process your application. Next, you would need to work with the lender to fill out and submit your application. If all goes well, you will be approved for the business LOC within a week to a fortnight.

How do you get a business credit card in Canada?

Obtaining a business credit card is substantially easier than obtaining a line of credit. First, you need to form your business structure. Next, you can approach a lender who will likely ask you to furnish documents such as proof of a bank account, bank statements, personal credit history etc. before processing your application. If all goes well, you can get approved for a business credit card relatively quickly.

Does a business line of credit affect my personal credit score?

Typically, you will be asked to provide your personal credit history when applying for a business line of credit. At that point of time, the inquiry conducted will likely have a small impact on your personal credit score. Over time though, the extent to which your personal credit score is impacted differs based on the amount of information that your business LOC lender reports to the credit bureaus.

Does a business credit card affect my personal credit score?

Typically, you will be asked to provide your personal credit history when applying for a business credit card. At that point of time, the inquiry conducted will likely have a small impact on your personal credit score. Over time, though, the extent to which your personal credit score is impacted differs based on the amount of information that your business credit card issuer reports to the credit bureaus.

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