How to Use a Business Line of Credit for Payroll, Inventory and Supplier Payments Without Overborrowing

Most profitable businesses still run short of cash at some point. Payroll leaves the account on Friday, but the customer invoice that would cover it is not due for another three weeks. A supplier wants payment before your busiest season starts generating revenue. None of this means the business is failing. It means money goes out and comes in on different schedules.

A business line of credit for working capital is designed for exactly this problem. Used well, it smooths the gaps. Used carelessly, it becomes a permanent crutch. This guide explains how a revolving facility works, where it fits in payroll, inventory, and supplier payments, and how to keep your borrowing under control.

Why Businesses Experience Short-Term Cash-Flow Gaps

Short-term cash flow gaps are not profitability issues but can be caused by several factors, including:

• Late-paying customers – You’re providing a service or product now but not getting paid until 30/45/60 days after invoicing.
• Fixed costs at set times – Payroll, rent and loan repayments are fixed.
• Seasonality – Retailers, distributors and manufacturers often purchase stock well in advance of when they will sell it.
• Supplier requirements – Some suppliers require payment in advance or upon delivery, whilst your customers pay on account.
• Unplanned costs – Equipment repairs, last-minute orders and price increases can cause a cash flow problem even if everything else is fine.

As these tend to be short-term, it’s better to have a flexible and repayable form of finance rather than a large loan which you’ll have to pay interest on for years.

How a Business Line of Credit Works

A credit line allows you to have access to funds up to an approved limit. You only borrow when needed. Then repay when you receive funds and borrow again (subject to the terms of the facility) as funds are repaid into your account.

Credit limits and amounts drawn

The credit limit is the maximum the lender can offer to you. The amount drawn down is the amount actually withdrawn. Therefore, if you have a credit limit of $100,000 and have drawn down $30,000, then you owe $30,000 but have $70,000 in remaining credit available.

Revolving credit and repayments

A revolving business credit means that it is a reusable facility. Any repayments you make (either in whole or in part) of your drawn-down amount are usually made available to you again, provided that you are within the terms and conditions of the facility. This is different to a term loan as the capital you repay will be lost.

Each lender will have their own specific repayment schedules, minimum repayments, timeframes for drawing down, and will review your facility for renewal. Always refer to your facility agreement.

Interest on drawn balances

Most will charge you for the amount you've withdrawn from your facility rather than the total facility. So if you only borrow $30,000 from your $100,000 facility, you'll only be charged interest on the $30,000 while the money is outstanding. Some facilities will also include fees like an origination fee, maintenance fee, or draw fee. Check what all the costs are.

Three Practical Uses of a Business Line of Credit for Working Capital

Managing payroll between customer payments

One of the most frequently asked questions is whether you can pay your staff using a business line of credit for working capital. In short, yes. These will generally be for working capital. Business line of credit for payroll is one of the most obvious uses. However, check that your agreement doesn't say that you can't.

A practical payroll cash-gap scenario

A marketing agency has a payroll of $40,000 that needs to be paid every two weeks. The current balance is $15,000, and there is an outstanding invoice of $60,000 to a client (to be paid in 12 days).

They will:

1. Take out $25,000 to ensure they can pay the payroll on time.

2. In 12 days, they receive the payment from their client and repay the $25,000 plus interest.

3. They have now replenished their available credit.

This is short-term borrowing with a clear expectation of income to repay the loan. We should look to operate this way. If we are constantly taking money out to pay our payroll with no income coming in to repay the loan, then we are showing we have a more serious issue with profitability.

Purchasing inventory before peak demand

Can I use a business credit line to purchase inventory? Generally speaking, yes, you can use a trade line of credit to buy stock. A retail business may require stock in September but not see sales until November/December. The loan is used to purchase the stock and then repaid with sales revenue.

This should be done responsibly by borrowing realistic amounts based on previous seasonal sales and confirmed orders. If you have unsold stock and have taken a loan, you will have a debt problem.

Paying suppliers while waiting for receivables

A business credit line for supplier payments can help if you need to make quicker payments to your suppliers. It can also have benefits for your business. If you get a discount from your supplier for prompt/early payment, it can pay for itself if you get an early payment discount that covers the borrowing costs. Just work out the sums first.

How Much of Your Credit Limit Should You Use?

It depends, but as a general rule, you should just think of it as a buffer.

A useful metric is utilisation. This is how much of your limit you have used (drawn balance) versus your approved limit.

This can have plenty of scope for surprises at 20%. But if you are at 90%, then a late payment from one customer can cause you to have nothing in the buffer. Many finance professionals like to keep the average well below the limit and get the balance back down regularly. The right level will depend on your margins, cash cycle, and facility details.

Two good habits to get into.

Get the balance down to a low or zero amount regularly. If you don’t, then you are using the line to fund your business, rather than just to fill in shortfalls.

Set aside some contingency cover. Decide how much you will not use for normal requirements.

Five common management mistakes in business line of credit for working capital

Below mentioned are the common mistakes: 

1. You are borrowing the maximum possible. It’s not necessarily essential that something is approved to borrow against it. Only borrow what is directly linked to a shortfall.
2. Funding long-term assets with short-term debt. Assets such as equipment, improvements, and growth should generally be funded through term loans or structured finance, as you can have unpredictable repayments using revolving credit.
3. No repayment source. For every draw, you need to know exactly what you’re going to receive to repay it and when.
4. Not considering the total cost. Rates, fees, and compounding can all affect how much you are really paying. Even if it seems cheap per day, if you leave money in there, it can build up.
5. Using debt to cover losses. If you are constantly spending more than you’re earning, then borrowing will only make your issue bigger by putting it off.

When a Business Line of Credit Is Not the Right Solution

Whilst revolving credit provides flexibility, there may be alternative options if:

• The company is not making a profit, and therefore a line of credit will not solve underlying issues.
• Large one-off investments are required. A term loan is usually the best option for large items with a long payback period.
• A single transaction is required. Purchase order or invoice finance could be a better fit.
• You aren’t disciplined in paying back. If you expect the facility to remain drawn down for an indefinite period, having a structured repayment plan can help keep you on track.
• The cash flow gaps are increasing. This may indicate pricing, collection, or cost issues that should be looked at first.

A Responsible-Borrowing Checklist

Before taking out the draw, consider:

• What is the exact cost, and is it a gap or loss?
• What payment are you expecting to receive back and when?
• Is it no more than your gap?
• Will you know how much interest and fees are, and what the repayment terms are?
• Will you be staying within your limit to give some buffer?
• Do you have a plan in place for late payments from the customer?
• Are you checking your balances regularly (monthly or more)?
• If you can't answer most of the above, then think twice before borrowing.

Putting It Into Practice

Business lines of credit are best seen as a short-term solution. You will want to borrow for a fixed period, pay back using the funds that you are expecting, and ensure the credit is topped up again. Using the correct tool, monitoring your usage and having some buffer.

You can find more information on the fundamentals here: Line of Credit Guide and Working Capital.

Need flexible access to working capital? Explore Spartan Capital's business line of credit and discover how revolving funding may support your operations.