Annual Clean-Up
Remember how every once in a while, your mom would suddenly declare some Saturday that you absolutely would NOT be leaving the house until your room was completely cleaned. The annual clean-up is the financial equivalent of that, only in this case a bank is your mom and a business with a line of credit is you as a kid.
In order to make sure that a business has viable prospects on its own, some lines of credit require an annual clean up. This means that at least once a year, the business with the credit line has to pay it back completely.
Businesses use lines of credit to smooth over slow parts of the year. So if you own an ice cream stand, you might use a line of credit in the winter to pay your employees when demand for cold treats is low. Then, in the summer, when lines are around the block, you can use the extra profits to pay back the credit line and get it back to even.
Banks want to make sure that a business can survive on its own and isn't just keeping itself open with the line of credit. They don't want the business to draw the credit down to nothing and then just declare bankruptcy. The annual clean up guards against this kind of eventuality, because it forces the business to prove it has the money at least sometimes in order to get even.
Related or Semi-related Video
Finance: What is Bankruptcy?260 Views
Finance a la' Shmoop what is bankruptcy well in the old days
this was bankruptcy you'd go to prison if you couldn't pay your bills and [People in prison for bankruptcy]
unfortunately there weren't and still aren't a lot of legal high wage earning
opportunities in prison working your way out of debt on the chain gang wasn't [Prisoners working outside]
really a thing back then so instead the burden would be on your family to pay
back the loan you'd promised to pay back and didn't ugly situation it paved the [Officer knocking on a prisoners family member to pay their debts]
way for some well today bankruptcy has a range of flavors that it comes in but
basically it exists as a legal vehicle to avoid the aforementioned situation a [Bankruptcy van driving]
bankrupt person and/or corporation stands in front of a judge they turn
their pockets inside out with a sad face and the judge then decide who will be [Person opens their pockets inside out in front of a judge]
paid when and how much well how does she decide the order for who gets paid back
when? well, it usually prioritizes employees and vendors owed a paycheck
above banks who have made a loan and under that umbrella all different types
of loans have different priorities if the bankrupt individual owns a home it's [bankrupt individual in his home on the toilet reading a newspaper]
usually sold out from under him and anything left after paying off the
mortgage is used to pay others even if you do survive a bankruptcy your credit
is pretty much ruined who's going to want to loan you money once you've
proven that you're not good with being loaned money yeah if you've defaulted in [a really low credit score chart for a bankrupt individual]
the past on promises to pay people back why wouldn't you do the same thing again
well remember that twenty dollars you loaned your buddy Eric that he never [Person loaning 20 dollars to friend Eric
paid back well how eager are you going to be to hook him up with another twenty
especially since you'd only be feeding his betting on frog fighting habit yeah [Eric betting money on frog fighting]
not so much so long Eric you'll get the help you need!
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