Many small business owners have realized the advantage of obtaining a business line of credit to take advantage of special purchasing offers and bridge occasional cash flow shortfalls, especially in seasonal businesses. Whether your business uses the cash or accrual method of accounting, the method of recording line of credit transactions is the same.
Zero Balance Line of Credit
If you have not yet used your line of credit, no journal entry is necessary to your accounting ledger. You do not need to reflect an open line of credit on your financial statements as it is not considered an asset for accounting purposes. In this aspect, a line of credit from a bank or other lender is no different than a business credit card where you do not record activity to the accounting general ledger until you use the card.
Recording a Line of Credit Draw
When you draw from your line of credit, you indicate the amount you need up to your line of credit limit and receive the funds by check, cash or transfer into your business checking account. Even though you will use the line of credit funds to pay business expenses, the withdrawal itself does not represent a business expense. To properly reflect the line of credit draw, record an increase to the checking account by the amount of funds drawn and an increase to the Line of Credit payable account for the amount drawn. Those accounts appear on the Balance Sheet report in the Assets and Liabilities sections.
Recording Use of Line of Credit Funds for Business Expenses
Because you already recorded the deposit of the line of credit funds as an increase to the line of credit payable and to your checking account, no other additional journal entries are required as you utilize the funds to pay business expenses. Instead, you record the payments as you would normally if you'd been using regular business cash flow to pay for them. At this point, the line of credit funds are treated no different than regular business cash collections from sales.
Payments on the Line of Credit
Once you draw funds from your line of credit, you will receive a monthly statement requesting payment until the line of credit is paid down to zero. The statement will reflect the amount of interest due on the line of credit for the prior month's usage as well as the required minimum principle amount that must be paid toward the line of credit open balance. You have to pay at least the minimum principle amount required and the interest charges, but you can also pay more if you are able.
Record the entire payment to the line of credit lender as a decrease to the checking account. Record the interest charged as an increase to the Interest expense account and all principal amounts paid as a decrease to the Line of Credit payable account.
- “Principles of Accounting”; A. Douglas Hillman, Richard F. Kochanek, Corine T. Norgaard; 1991