TL;DR
A line of credit should cycle up and down, not sit at a permanent balance you never clear. Here is the disciplined system that keeps it a buffer instead of silent debt that costs you thousands a year in interest.
A line of credit is one of the most useful tools a small business can have. It is also one of the easiest to misuse. Most owners who end up with a permanently maxed LOC did not intend for it to work out that way. It happened gradually, one draw at a time.
How a Line of Credit Is Supposed to Work
A business line of credit is designed for short-term cash flow gaps. You draw on it when cash is tight, then repay it when cash comes in. The balance should go up and down. If it only ever goes up, something has gone wrong.
The key principle: a LOC should bridge a timing gap, not fund an ongoing shortfall. Payroll is due Friday but a client invoice clears next Tuesday? That is what a LOC is for. You are covering four days. You repay as soon as the cash lands.
If you are drawing on your LOC every month to cover expenses and never fully paying it back, you have a revenue or margin problem. The LOC is masking it.
What Owners Get Wrong and Why It Costs Money
The most common mistake is treating the LOC as a second operating account. Owners get approved for $150,000, they see $150,000 available, and it starts to feel like money they have rather than money they borrowed.
Interest on a revolving LOC typically runs prime plus one to three percent. Right now that is not cheap. A $100,000 balance carried all year can cost $8,000 to $10,000 in interest. That is money coming straight off your bottom line every year, for a balance you never meant to carry permanently.
The second mistake is using a short-term tool to solve a long-term problem. Equipment financing, owner distributions, and slow-paying clients are not LOC problems. They require different solutions. When you use a LOC as the fix for all of them, you end up with a balance that never clears because it was never meant to clear on a short cycle.
The CFO Perspective: What a Healthy LOC Looks Like
A well-managed LOC has a clear pattern in the bank statement. The balance goes up around payroll or supplier payment dates. It comes back down when receivables clear. Over any given quarter, the average balance should be well below the limit.
One service business I worked with carried a $180,000 LOC balance that had not moved in over a year. When we pulled the cash flow history, the LOC had been drawn to cover three separate slow months twelve months earlier and was never repaid because each subsequent month had just enough cash to cover current expenses, not catch-up repayments. The fix was not complicated. We set a mandatory monthly LOC repayment as a fixed line item in the cash plan, the same way rent is a fixed line item. Within six months the balance was cleared. The discipline of treating repayment as non-negotiable was the whole solution.
How to Structure It So This Does Not Happen
The LOC needs rules before you draw on it, not after.
- Set a ceiling you will not breach in normal operations. If your limit is $150,000, decide that $75,000 is your personal ceiling for routine draws. The top half of the limit is emergency-only. This gives you headroom when you actually need it.
- Define exactly what qualifies as a LOC draw. Write it down. Payroll bridge: yes. Slow receivable: yes. New equipment: no. Owner distribution: no. Marketing campaign: no. If it is not on the approved list, find another funding source.
- Set a mandatory repayment timeline. Every draw should have a repayment date attached to it before you pull the money. If you are bridging a receivable, the repayment date is the day that receivable clears. If you do not have a repayment date, you should not be drawing.
- Review the balance monthly, not quarterly. Put the LOC balance on your monthly financial review dashboard. If it did not decrease from last month, that is a conversation to have immediately, not at year end.
- Separate your LOC from your operating account visually. Keep it in a different account. Do not have it auto-replenish your chequing account. Manual draws create friction, and friction is useful. It forces you to make a conscious decision each time.
When the Balance Will Not Go Down
If you have been trying to repay your LOC for six months and the balance keeps creeping back up, the LOC is not the problem. You have a cash flow structural issue. That usually means one of three things: your margins are too thin to support your cost base, your receivables are too slow, or your owner draws are too high relative to what the business earns. A LOC can delay the moment you face that reality. It cannot fix it.
The right move at that point is to build a 13-week cash flow forecast and see exactly where the cash is going. Most owners who do this for the first time are surprised by what they find. The leak is usually one or two specific things, not a general vague shortfall.
What to Do About It: Summary
- Pull your LOC transaction history for the past 12 months. Chart the balance by month. If it never meaningfully declined, you have a problem to address.
- Write a one-page policy for what your LOC can and cannot be used for. Share it with anyone who has signing authority.
- Add a mandatory monthly repayment line to your cash plan. Even $5,000 a month is a commitment that changes the trajectory.
- Build a 13-week cash flow forecast. If you cannot repay the LOC from projected cash, you need a revenue or margin fix, not more credit.
- If you are not sure which problem you have, talk to a CFO before your bank does. Lenders notice when a LOC never cycles.
A line of credit is a powerful tool when it is used correctly. If yours feels more like a permanent overdraft, now is the time to fix the habit. Book a free call at peterxiacpa.com/book.
Next step: run your numbers through the free CFO scorecard.
Frequently Asked Questions
- How often should I repay my business line of credit?
- Every draw should have a repayment date attached before you pull the funds. If you are bridging a specific receivable, repay when that receivable clears. A LOC balance should visibly decline at least once a quarter. If it only goes up, you have a structural cash flow issue to address.
- Is it bad to use a line of credit every month?
- Regular draws are fine if the balance consistently comes back down. The problem is when the balance stays elevated month after month and never returns to near zero. That pattern means the LOC is covering an ongoing shortfall, not a short-term timing gap.
- What is the difference between using a LOC for cash flow versus taking on permanent debt?
- A cash flow LOC bridges a gap between when money goes out and when it comes in. The balance clears within days or weeks. Permanent debt is when the LOC funds something that does not generate near-term cash, like equipment or an owner draw, and the balance lingers for months or years.
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