The line of credit mistakes that surface at renewal time

The mistakes in one paragraph

The biggest line of credit mistakes are using it as permanent money that never gets paid down, funding long-term purchases such as vehicles or build-outs with it, missing the financial reporting the loan agreement requires, waiting until a cash crisis to apply, and assuming the line will automatically renew. Each one makes the line less useful when you need it and makes the bank's annual review harder. Most are easy to avoid once you understand what a line is designed to do.

Alongside the deposit relationships I manage at Frost Bank, I work on lines of credit for small and mid-size companies. The patterns below come up again and again in renewal conversations. None of them mean the owner did anything dishonest. They usually mean nobody explained how a line is supposed to behave.

What a line of credit is for

A business line of credit is a revolving limit you draw when cash is short and repay when collections come in. You generally pay interest only on what is outstanding. It is built for timing gaps: paying staff and suppliers before customers pay you, carrying a seasonal build-up of inventory, or taking on a large order. Banks describe lines in those terms; Frost's own financing page, for example, presents them as flexible, as-needed funds, distinct from term loans for expansion, equipment or vehicles.

Lines are usually reviewed and renewed on a set schedule, often annually, and the terms, including any reporting requirements and covenants, are written in the loan agreement. That agreement is the document to read, not a summary from memory. If you are still deciding whether a line or a term loan suits your situation, my earlier guide on when a line of credit beats a loan covers that choice.

Not every line is a conventional bank product. The SBA's 7(a) program includes a Working Capital Pilot that offers monitored lines of credit, and the SBA lists a maximum maturity of 60 months for those loans. Monitored lines typically come with closer reporting on receivables and inventory, so the reporting discipline described below matters even more if that is the route you take.

Mistake one: a balance that never comes down

A line that sits at or near its limit for a full year is no longer funding timing gaps. It has become permanent capital, which is a different kind of financing. Lenders notice. Some lines include a requirement to pay the balance down to zero, or close to it, for a period each year, sometimes called a rest or clean-up period, to show the line is truly revolving. Whether yours has one depends on the agreement.

Even without that requirement, a line that never revolves raises a fair question at renewal: is the business using it to cover losses or a permanent shortfall? If the honest answer is yes, the solution may be a term loan, more equity or a change in operations, not a bigger line. A good banker will raise this with you before renewal, not at it.

Mistake two: buying long-lived things with short-term money

A truck, a machine, a build-out or a down payment on a building will serve the business for years. Funding it from a line of credit ties up the line for the same years, so when the real cash gap arrives, in a slow month or a big order, there is nothing left to draw. It also distorts the picture the bank sees at renewal, because the line looks fully used even if day-to-day cash flow is fine.

Match the financing to the life of what you are buying. Equipment financing or a term loan spreads the cost of an asset across its useful life and leaves the line free for its real job. For larger purchases, SBA-backed loans are another option, and I compare them in my guide to SBA and conventional bank loans.

Mistake three: treating the reporting as optional

Many line agreements require the business to send financial statements on a schedule, such as annual tax returns and year-end statements, and sometimes interim statements, receivables agings or borrowing base reports. Owners often sign the agreement, draw on the line and forget those obligations until the banker calls. Late or missing reporting can be a breach of the agreement, and at minimum it slows the renewal.

Put the reporting dates on the calendar the day the line closes, and send the documents a little early. If your books are not ready on time, tell your banker before the deadline rather than after. A fractional CFO or a strong bookkeeper can make this routine; what a fractional CFO does explains how that kind of help works for a growing company.

Myths that lead owners astray

A handful of beliefs come up so often that they are worth addressing directly. Each has a grain of truth that makes it persuasive, which is why it sticks.

• Myth: you should apply only when you need the money. In reality, a line is easiest to get when the business is strong and the request looks planned, not urgent.
• Myth: an unused line is wasted. Its value is that it is there when needed; some lines carry fees, so ask, but a line you rarely touch can still be worth having.
• Myth: the line renews automatically. Renewal is a fresh review of the business, and the bank may change, reduce or decline it.
• Myth: a bigger limit is always better. A limit far beyond your needs can mean higher fees and more scrutiny, with no benefit.
• Myth: the bank only cares about the payment history. Banks look at the whole company at renewal, including cash flow trends, financial reporting and how the line was used.

Mistake four: keeping the banker in the dark

Businesses have bad quarters. A large customer pays late, a project runs over, margins shrink. The owners who handle this best tell their banker early, explain what happened and what they are doing about it. The ones who struggle hope it resolves before anyone notices. It rarely does, and a surprise discovered at renewal is much harder to work through than a problem raised in real time.

The same applies to good news and big changes. A new location, a major contract, a new partner or the sale of part of the business can all affect the credit. Tell your banker before, not after. It is the difference between a lender who helps you plan and one who has to react. A short email or call each quarter with a few headline numbers is often enough to keep the relationship current.

Mistake five: commingled money and messy statements

If personal and business money run through the same accounts, or the business pays personal expenses routinely, the statements a lender reviews at renewal will be hard to read. That makes it harder to show the cash flow that supports the line. Keep business money in business accounts and pay yourself on a schedule. My guide on running a business through a personal account explains why this matters well beyond lending.

Clean books also make your own decisions better. When you can see each month's low balance, receivables aging and draws on the line in one place, you can tell whether the line is doing its job or covering a deeper problem.

Mistake six: applying in the middle of a cash crunch

The worst time to ask for a line of credit is the week payroll is at risk. Financial statements are usually behind, the request looks reactive, and there is no time for the normal review. Even if the business is fundamentally sound, the bank is being asked to decide quickly with incomplete information, and the owner is negotiating from a weak position.

The better approach is to put a line in place when things are going well, sized to the timing gaps you can already see in your statements, and then leave it largely untouched until you need it. An owner who sets up a line a year before expecting to use it turns a potential emergency into a phone call. For a growing Dallas company with a busy season, that usually means arranging the line in the quiet months, when the books are current and there is time to answer the bank's questions properly.

Getting ready for a smooth renewal

A renewal should feel like an annual check-up, not an exam. About two to three months before the maturity date, gather your latest financial statements and tax returns, review how the line was used over the year and note anything that changed in the business. Then meet with your banker to talk through the next year: is the limit still right, is the structure still right, and is anything coming that needs different financing?

For owners in Dallas–Fort Worth, I try to have that conversation with clients well before the date so there are no surprises on either side. Every agreement and every bank is different, so treat this as general information and read your own loan documents with your accountant. The underlying idea holds everywhere, though: use the line for timing, finance long-lived assets separately, report on time and keep your banker informed.

• Calendar the maturity date and all reporting deadlines
• Review the year's draws, repayments and lowest balances
• Send current financials and tax returns ahead of time
• Raise any problems or big changes before the review
• Ask whether the limit and structure still fit next year

Questions people ask me