The short answer. Manage an LOC as a working capital tool. Draw for specific short-term needs. Pay down when the cycle completes. Keep the average balance below 50 percent of the line. If the average balance climbs above 50 percent for two consecutive quarters, either restate MMP to treat the balance as effective term debt or restructure it into a real term loan. A maxed-out LOC is not a line. It is unstructured term debt at variable rates.
The Working Capital Tool
The purpose of an LOC is to bridge specific short-term cash gaps. A large customer paying on 60 days instead of 30. A material purchase that funds a specific job. A seasonal buildup in inventory before peak.
In every case, the draw has a payback source built into the transaction. The 60-day receivable comes in. The job invoices. The peak season sells through. The LOC gets paid down when the payback source hits the bank.
The bank underwriting an LOC expects to see this pattern. Draws and paydowns cycling through the year. Average utilization below 50 percent. Zero balance at some point during the year.
When The Pattern Breaks
If the LOC has been at 70 to 90 percent utilization for two quarters or more, the pattern has broken. The LOC is no longer bridging short-term gaps. It is funding a permanent capital shortfall.
The bank will notice. Some banks will convert the LOC to a term loan at renewal, which is often a good outcome because it locks in the rate and creates an amortization schedule.
Some banks will reduce or freeze the line, which is a bad outcome because it removes the flexibility without paying down the balance.
The best move when the pattern is breaking is to initiate the conversion yourself. Talk to the bank. Propose converting the current balance to a 3 to 5 year term loan and reducing the LOC to the actual working capital cycle need. The bank will usually agree because it improves their risk position.
The MMP Restatement
When the LOC average balance rises above 50 percent, the balance above the working capital cycle is effectively term debt. Restate MMP to reflect it.
Take the average balance above 50 percent. Multiply by the current LOC rate (typically prime plus 2 to 5). That is annual interest expense you were already paying.
Now add the principal repayment. If you intend to pay down the balance over 3 to 5 years, the monthly principal is the balance divided by 36 to 60. Grossed up for taxes at 1.30, that goes into Layer 1 MMP Debt Service sub-layer.
MMP will rise. Layer Cake will show a higher Breakeven. If current pricing does not clear the new Breakeven, either reprice or restructure the LOC into a longer-term facility with more manageable amortization.
Frequently Asked Questions
How large should my LOC be relative to revenue?
Rule of thumb is 10 to 25 percent of annual revenue for a business with a normal working capital cycle. More for businesses with long collection cycles or heavy inventory. Less for businesses with fast turns.
Is it bad to have an LOC and never use it?
No. Unused capacity is expensive to nothing. It is a option you paid for through the annual fee, and it is worth having when a real short-term need arises. Do not draw just to prove the line is active.
What if the bank cuts my line without warning?
Rare but happens, especially during credit contractions. Options: switch banks (takes 60 to 120 days), draw the full remaining line before it is reduced, or convert to a term loan if the bank will accept it. Prevent by maintaining a healthy revolving pattern.
Should I have multiple LOCs at multiple banks?
For businesses over $5 million revenue, yes. Diversifies bank relationship risk. Each line should have its own use case (working capital, seasonal, opportunistic) rather than duplicating.