January 13, 2017

Lines of credit can be a useful tool for pet retailers. They can also become a crutch or a way for a store owner with a fundamentally bad operational model to avoid dealing with the real problems facing the business.

It’s a simple enough concept, and most banks are happy to extend a line of credit to business customers, especially longtime customers who don’t have a history of credit issues. The banks will take a certain amount of money—let’s say $15,000, for example—and make it available to the business to access as needed.

If you haven’t accessed any, you haven’t borrowed anything and you don’t owe anything, principal or interest. But if the line of credit has been approved, you can tap it quickly and easily when you need it. Once you borrow against the line of credit, you own on it just as you would on a normal business loan. Usually you have to make at least some sort of minimum payment—and oh, yes, you pay interest on it, too.

That’s why banks offer them. It’s why they want you to access them. It’s a financial product, and they profit from the interest payments they receive back.

A lot of people don’t know that banks “buy money.” They will often fund a loan or line of credit by acquiring capital from an outside source that charges the bank a much lower interest rate than the customer will pay. The bank’s source knows that the bank is a good risk, whereas the bank’s customer may or may not be a good risk. But regardless, the bank customer is always going to pay a higher interest rate than the bank, so when you access your line of credit, it’s always going to be a win for the bank—unless, of course, you don’t pay it back.

That’s a bigger risk for the bank when they’re making a standalone unsecured business loan. Lines of credit involve relatively small amounts of money, and the banks can usually get a pretty good sense of whether red flags are going up. If a customer is struggling to make even minimum payments on a partial draw from a line of credit, that’s usually a pretty good clue that something’s not right. In that situation, the bank has the opportunity to step in and work with the customer to manage the problem before much larger amounts of money are at risk.

The risks involved with lines of credit are actually bigger for the customer than they are for the bank, mainly because of the risk that the line of credit will be misused. Retailers often find themselves with cash flow challenges. Overhead tends to be set, but sales and revenue can be unpredictable. It’s easy to look at that line of credit when a short-term cash crunch takes you by surprise and say, “Well, I’ll just do it this once.”

You have the best of intentions to pay it right back as soon as you follow that slow period with a strong one. And if that doesn’t happen, no problem; you’ll make payments. You won’t let it get out of control. At least, that’s what you tell yourself.

But psychologically, the line of credit can become an enabler of denial. A well-run business hitting its revenue targets should theoretically be funding itself out of its own cash flow, with cash left over to add to cash reserves or to reinvest in the business. Things go wrong, of course, but this should be the normal state of affairs.

If you always have credit extended and something is always going wrong that keeps you from eliminating the debt, then the problem isn’t that something’s always going wrong. The problem is that you haven’t developed a business model you can consistently operate at a profit. A solid business model accounts for occasional problems and turns a profit even when they occur.

If you owe at least something on your line of credit more often than you don’t owe anything on it, you’ve got more fundamental problems with your business than random spates of bad luck.

If you find yourself accessing your line of credit to cover expenses while you’re undertaking a massive push to find new customers because revenue is chronically falling short of your goals, then you’re using that line of credit in the wrong way. You need to first reduce your overhead to fall in line with your reliable income, then figure out how to grow the revenue.

And if at any point you find yourself wanting to ask the bank to increase the line of credit available to you, you should take a step back and think about that. It’s one thing if the business is doing so well that you need to expand and the line of credit would help pay for the expansion—that you can probably justify. But if you’re after more credit because you can’t seem to pay your bills with what they’ve already made available to you, you’re in very dangerous territory.

Ideally, a line of credit should be little more than a short-term failsafe—something that’s rarely, if ever, used. If you need yours to be more than that, it’s time to reconsider the entire concept of your store. Do it today before you take on more debt that a faulty business model may not allow you to repay.

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