Small Business Line of Credit: How It Works and When to Use One
ADS Team
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August 8, 2026
3 months ago
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In short: A line of credit is an approved limit you draw against and repay repeatedly, paying interest only on the balance drawn. It suits recurring, unpredictable working capital needs - stock, wages, the gap between paying suppliers and being paid - where a term loan's fixed repayment would not flex with the cycle.
Key takeaways
- You pay interest only on what is drawn, not the approved limit.
- Best for recurring gaps; a term loan remains better for a one-off purchase.
- Most facilities carry a line fee on the limit whether you draw it or not.
- Facilities are reviewed periodically and can be reduced - do not treat the limit as permanent.
Line of credit, overdraft or term loan?
| Line of credit | Overdraft | Term loan | |
|---|---|---|---|
| Structure | Separate revolving facility | Attached to your trading account | Lump sum, fixed term |
| Interest on | Drawn balance | Negative balance | Full amount from day one |
| Repayment | Interest, plus principal at will | Fluctuates with the account | Fixed schedule |
| Best for | Recurring working capital | Short, frequent dips | A defined purchase |
What it costs
Three charges to compare, not one:
- Interest on the drawn balance. Secured facilities against property price far below unsecured ones.
- Line fee - typically a percentage of the approved limit annually, payable whether or not you draw. On a $250,000 limit a 1.5% line fee is $3,750 a year before any interest.
- Establishment and review fees at set-up and at each periodic review.
A larger limit than you need is not free. Size it to the actual cash conversion cycle rather than to the largest number offered.
Sizing it properly
The gap you need to fund is driven by how long cash is tied up. If customers take 55 days to pay, stock sits 40 days and you pay suppliers in 30, your cash conversion cycle is 65 days.
On $4m of revenue that is roughly $712,000 of working capital committed at any moment. A facility materially below that will be permanently drawn - which is a sign you need term funding or better collection, not a bigger limit.
Frequently asked questions
Does an unused limit cost anything?
Usually yes, through the line fee charged on the approved limit regardless of usage. That is the main reason not to take a larger limit "just in case".
Can the bank reduce my limit?
Yes. Facilities are reviewed periodically and limits can be reduced or withdrawn, typically at review or if covenants are breached. Do not build a business model that assumes the limit is permanent.
Is a line of credit secured?
Larger facilities almost always are, usually by property or a general security agreement over business assets. Small unsecured limits exist but price considerably higher.
Related reading
- Business Loan Types: A Complete Australian Guide
- Low Doc Business Loans: How They Work and What They Cost
- Bad Credit Business Loans: What Is Actually Available
Sources
- Business finance options — business.gov.au
- Business lending rates, statistical table F7 — Reserve Bank of Australia
Rates checked as at 2 September 2026. Interest rates, lender policies and government schemes change frequently. Figures in this article are illustrative and were accurate at the date shown.
General advice warning: This article contains general information only. It does not take into account your objectives, financial situation or needs, and it is not personal credit or financial advice. Consider whether it is appropriate for you and seek advice from a licensed credit representative before acting.
Any interest rate shown is an example only and is not an offer of credit. Where a rate is quoted, the applicable comparison rate is available from the relevant lender and should be considered alongside it.
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