Application of credit

One of the mistakes small business owners make is mis-applying capital sources to capital needs. For example, using current operating cash flow to purchase a fixture that will last for years, instead of taking out a term loan from a bank with a multi-year payment plan.

Long-term needs such as equipment purchases should be financed with long-term capital, such as equity or a term loan, instead of a revolving loan. Your personal credit line may need to be repaid before the equipment is delivering sufficient added profits to your business, causing you to use other resources to repay the line. In the process, you have pulled precious working capital out of that other area of the business at the very time you are trying to finance your growth.

The rule of thumb is: finance short-term needs (receivables, inventory) with short-term borrowing (such as a credit line) and long-term capital requirements with long-term debt. That way you're more closely matching when the value is gained with the time frame of the debt service payments.