Business line of credit: how it works and when to use

Published Thursday 26 February 2026

Table of contents

• What is a business line of credit?
• How does a line of credit work?
• Types of business lines of credit
• Example of a line of credit
• Line of credit vs term loan
• How is a line of credit different from a credit card?
• Advantages and disadvantages of a business line of credit
• Common business uses for a line of credit
• Risks of over-using a line of credit
• How do you get a line of credit?
• Managing your line of credit with Xero
• FAQs on business lines of credit

Key takeaways

• Apply for a business line of credit before you need it, when your business is financially strong and cash flow is healthy, as this increases your chances of approval with better terms.
• Use a line of credit for short-term, variable funding needs like seasonal cash flow gaps, inventory purchases, or emergency repairs, rather than covering ongoing losses or long-term expenses.
• Recognise that you only pay interest on the amount you actually draw from your credit limit, not the total available amount, making it more cost-effective than borrowing a lump sum you might not fully use.
• Monitor your usage carefully to avoid over-reliance, watching for warning signs like regularly maxing out your limit or using new draws to repay old ones, which can signal deeper cash flow problems.

What is a business line of credit?

A business line of credit is a flexible financing option that gives your business access to a set amount of funds you can draw from as needed. It works similarly to a credit card: you only pay interest on the amount you actually use, not the total credit limit available.

Unlike a traditional loan where you receive a lump sum upfront, a line of credit lets you borrow, repay, and borrow again without reapplying. This makes it ideal for managing cash flow gaps, especially for businesses that require significant working capital investment in assets like inventory and receivables.

How does a line of credit work?

A business line of credit gives you access to a pre-approved pool of funds up to a set limit. You withdraw what you need, when you need it, and only pay interest on the amount you've borrowed.

Here's what makes it flexible:

• Draw funds on demand: Access money whenever cash flow gets tight or an opportunity appears
• Pay interest only on what you use: If your limit is £50,000 but you only borrow £10,000, you're charged interest on £10,000
• Repay and reuse: With a revolving line of credit, repaid funds become available again without reapplying

Some lines of credit expire after a set period, while revolving lines remain open as long as you meet the lender's terms. For instance, similar overdraft facilities are often provided for a fixed period of one year, at which point they are reviewed and renewed as appropriate.

Types of business lines of credit

Business lines of credit come in different forms. Understanding the options helps you choose the right fit for your situation.

Revolving vs non-revolving lines of credit

Revolving lines of credit let you borrow, repay, and borrow again up to your limit. The credit refreshes as you pay it back, making it useful for ongoing or unpredictable expenses.

Non-revolving lines of credit work differently. Once you've drawn the funds and repaid them, you can't access that credit again. These suit one-off projects or purchases where you know the total cost upfront.

Secured vs unsecured lines of credit

Secured lines of credit require collateral, such as property, equipment, or inventory. Because the lender has security, you'll typically get:

• lower interest rates
• higher credit limits
• easier approval if your credit history is limited

Unsecured lines of credit don't require collateral, similar to how commercial paper is unsecured and used for short-term financing. They're faster to set up but usually come with higher interest rates and lower limits because lenders rely more heavily on your credit score and business financials to assess risk.

Example of a line of credit

Here's how a business line of credit works in practice:

A bank approves your business for a £50,000 line of credit. You withdraw £10,000 to buy inventory. You'll only pay interest on that £10,000, while the remaining £40,000 stays available.

A few weeks later, you need £5,000 for new shop fittings. You can withdraw that amount even before you've repaid the original £10,000.

Your total borrowed is now £15,000, and that's the amount you're charged interest on. Once you repay some or all of it, those funds become available to borrow again.

Line of credit vs term loan

The main difference is structure. A term loan gives you a lump sum upfront with fixed repayments over a set period. A line of credit lets you draw funds as needed and only pay interest on what you use.

Here's how they compare:

• Loan amount: Term loans typically offer larger amounts, making them better for major purchases like property or equipment
• Repayment: Term loans have fixed monthly payments; lines of credit offer flexible repayment as you draw and repay
• Interest rates: Term loans often have lower rates; lines of credit may charge higher rates for their flexibility
• Best for: Term loans suit one-off, high-cost investments; lines of credit suit unpredictable, short-term needs like inventory, repairs, or bridging cash flow gaps

A line of credit works as a financial cushion when you're not sure exactly how much you'll need or when.

How is a line of credit different from a credit card?

Both give you flexible access to funds, but a business line of credit typically offers better terms for larger amounts.

Key differences:

• Security: Business credit cards are almost always unsecured. Lines of credit can be secured with collateral, which lowers your interest rate and increases your limit.
• Interest rates: Credit cards usually charge higher rates than secured lines of credit.
• Credit limits: Lines of credit generally offer higher limits, making them better for larger expenses.
• Access to funds: Credit cards are convenient for everyday purchases; lines of credit are better for withdrawing cash or making larger payments.

If you need flexibility for smaller, frequent purchases, a credit card may be better. For larger, less predictable funding needs, a line of credit is usually the better choice.

Advantages and disadvantages of a business line of credit

Like any financing option, a line of credit has trade-offs. Here's what to weigh up.

Advantages

• Flexibility: Borrow only what you need, when you need it
• Pay for what you use: Interest is charged only on drawn funds, not your total limit
• Reusable credit: With revolving lines, repaid funds become available again
• Quick access: Once approved, you can draw funds without reapplying
• Build business credit: Responsible use can strengthen your credit profile for future borrowing

Disadvantages

• Variable interest rates: Rates may fluctuate, making costs harder to predict
• Fees: Some lenders charge maintenance fees, draw fees, or inactivity fees
• Lower limits: You'll typically get less than with a term loan
• Qualification requirements: Lenders often require strong credit and established business history
• Risk of over-reliance: Easy access to funds can lead to borrowing more than you need

Common business uses for a line of credit

A line of credit works best for short-term, variable funding needs. Other short-term financing tools like commercial paper have an average life that is typically about 40 days in Britain. Here are the most common scenarios:

• Seasonal cash flow: Cover overheads or payroll during slow periods when revenue dips
• Bridging payment gaps: Pay suppliers or staff while waiting for clients to settle invoices
• Inventory opportunities: Take advantage of bulk discounts or stock up before busy periods
• Equipment repairs: Handle unexpected breakdowns without disrupting operations
• Emergency expenses: Address urgent costs that can't wait for a traditional loan

Repayments are more flexible than with a term loan. You can generally pay lump sums without penalties, which helps you clear the balance quickly when cash flow improves.

Risks of over-using a line of credit

A line of credit isn't the right solution for every funding need. Using it incorrectly can create bigger financial problems.

When to avoid using a line of credit:

• Covering ongoing losses: If your business consistently spends more than it earns, borrowing won't fix the underlying issue
• Long-term payroll funding: Routine expenses should come from revenue, not credit
• Replacing proper cash flow management: Continual reliance on credit may signal deeper problems with your invoicing or collections process

Warning signs you're over-relying on credit:

• You're regularly maxing out your limit
• You're using new draws to repay old ones
• Interest payments are eating into your margins

If you need finance for the medium to long term, a term loan with lower interest rates may be a better fit. If cash flow is the root issue, consider reviewing your accounts receivable process or speaking with your accountant.

How do you get a line of credit?

To get a business line of credit, you'll need to apply through a bank, building society, or alternative lender. The process typically involves submitting your business financials and credit history for review.

Apply before you need it. If you apply when business is strong and cash flow is healthy, you're more likely to get approved with better terms. Waiting until you're in a tight spot can work against you.

What lenders typically require:

• Financial documents: Bank statements, balance sheet, and income statements (usually covering the past one to two years)
• Business credit history: Your track record of repaying debts and managing credit
• Personal credit history: Some lenders check the owner's personal credit, especially for smaller businesses
• Time in business: Many lenders require at least one to two years of trading history with consistent revenue

You can download our free balance sheet template to prepare the information lenders need.

Maintaining your line of credit. Once approved, you may need to follow certain rules to keep your credit line open. These can include staying above a minimum debt level, repaying all credit periodically, or maintaining a particular net worth. Check your agreement for specific requirements.

Managing your line of credit with Xero

A business line of credit gives you flexible access to funds when cash flow gets tight or opportunities arise. Whether you're covering seasonal gaps, bridging invoice delays, or handling unexpected repairs, it's a useful tool to have in place before you need it.

Using a line of credit well means knowing exactly where your cash stands. When you can see your cash flow in real time, you'll know when to draw funds, how much to borrow, and when you can afford to pay it back.

Accurate cash flow tracking helps when managing a line of credit. Get one month free to see how Xero helps you monitor spending, track available credit, and make informed borrowing decisions.

FAQs on business lines of credit

Here are answers to common questions about business lines of credit.

How long does it take to get approved for a business line of credit?

Approval times vary by lender. Traditional banks may take one to four weeks, while online lenders can approve applications within 24–48 hours. Having your documents ready speeds up the process.

What credit score do I need for a business line of credit?

Requirements vary by lender, with some alternative lenders accepting lower scores in exchange for higher rates. A stronger credit history generally improves your chances of approval and helps you secure better terms.

Can I have multiple business lines of credit?

Yes, you can hold multiple lines of credit from different lenders. However, each application may affect your credit score, and lenders will consider your total debt when assessing new applications.

Is interest charged on unused credit?

No, you only pay interest on the amount you've actually drawn. However, some lenders charge maintenance fees or inactivity fees on unused credit lines, so check your agreement.

When should I use a term loan instead of a line of credit?

Choose a term loan when you need a large, specific amount for a one-off purchase like equipment or property. Term loans typically offer lower interest rates and higher amounts, but with fixed repayments and less flexibility.