Lines of Credit. A line of credit is not a loan, it is a very favorable method of securing a loan. The cliche´ describing this arrangement is ‘‘borrow when you don’t need it so that you will have it when you do.’’

Suppose that a company is considering expansion plans or a major expenditure, to take place sometime within the next six months. The company’s balance sheet is strong, and its need for the loan is uncertain, or at least not immediate. The company can go to the bank and arrange for a line of credit. This is an advance reservation that makes funds available, to be used only if and when they are needed.

The advantages of a line of credit are:

• The loan is arranged at the timing of the borrower.
• The funds are available; they can be used or not, at the choice of the borrower.
• The company is in a position to make major purchase commitments knowing that this and maybe other financing
• options are available.
• It provides considerable purchase price bargaining power.
• Interest payments do not begin until the funds are actually needed.

The company will pay a reservation fee, probably in the range of 1 percent of the total line. Payment terms, interest, and other fees and collateral requirements will be the same as those on any other loan and are always negotiable. This is conceptually the same as a homeowner’s equity line of credit.

Credit Cards. More and more customer orders are being placed by phone or by computer over the Internet. Allowing the customer to pay by credit card accomplishes a number of things:

• It eliminates accounts receivable, thus eliminating the wait for the money and the associated paperwork.
• The customer’s creditworthiness need not be evaluated.
• There will be no overdue receivables.
• The customers can take as much time as they want to pay.

For smaller orders, waiting for customer payments and making the often inevitable collection phone calls eliminates the profit. Although the company must pay the credit card fee, which is approximately 2 percent, accepting credit cards will make small orders profitable.

Compensating Balances. Requiring compensating balances is a bank strategy that increases the effective cost of borrowing money without increasing the stated interest rate. A compensating balance means that the borrower is required to keep a certain minimum balance in the checking account at all times.

If a company borrows $1,000,000 for one year at 10 percent, the interest rate is obviously 10 percent. If, however, a 10 percent compensating balance is required, the borrower has the effective use of only $900,000. This results in an effective rate of 11 percent. If the borrower really needs $1.0 million, it must borrow approximately $1.1 million.

Along with loan origination fees, collateral audit fees, search fees, and other such charges, compensating balances are a cost of borrowing and can be negotiated.

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