How to Set Up a Line of Credit in QuickBooks

Setting up a line of credit (LOC) in QuickBooks feels like it should be simple, but it's one of those tasks that can easily lead to incorrect financial statements if not handled properly. Unlike a standard bank account, a line of credit is a liability, and tracking its draws, payments, and interest requires a specific approach. This guide will walk you through the correct, step-by-step process for setting up and managing a line of credit in QuickBooks, ensuring your balance sheet is always accurate.

Why a Line of Credit Requires a Special Setup

The most common mistake businesses make is setting up a line of credit as a bank account. It’s an understandable error—money comes in, money goes out. However, a line of credit isn't an asset; you don't own the funds until you draw them, and at that point, you owe them back. It is a loan.

Classifying it as a bank account artificially inflates your assets. Instead, it needs to be set up as a liability, which reflects the money your company owes. Specifically, we'll treat it as an "Other Current Liability."

Here’s why this distinction is so important:

• Accurate Balance Sheet: A properly configured LOC appears in the liability section of your Balance Sheet, giving a true picture of what your company owes at any given time. Setting it up incorrectly can misrepresent your financial health to lenders, investors, and management.
• Correct Interest Tracking: Payments on a line of credit consist of two parts: a principal payment (which reduces the liability) and an interest payment (which is an expense). Mixing these up distorts your Profit & Loss statement and your total liability.
• Clean Reconciliations: When the LOC balance is tracked as a liability, you can reconcile the account against the lender's monthly statements, just like a bank or credit card account. This helps you catch errors and maintain confidence in your books.

Step-by-Step: Creating the Line of Credit Account

First, you need to add the line of credit to your Chart of Accounts. This creates the bucket where you'll track the balance you owe. The opening balance should be $0 because you don't owe anything until you make your first draw.

Follow these steps in QuickBooks Online:

1. Navigate to the Chart of Accounts. You can find this by clicking the gear icon in the top right and selecting "Chart of Accounts" or by going to "Accounting" on the left-hand navigation panel.
2. Click the green New button at the top right to create a new account.
3. In the "Account Type" dropdown, select Other Current Liabilities. This is reserved for debts you expect to pay within one year, which fits most revolving lines of credit. If your LOC agreement extends beyond a year, you could choose "Long-Term Liability," but "Other Current Liability" is generally the best fit.
4. In the "Detail Type" dropdown, choose Line of Credit. This helps QuickBooks categorize the account for reporting purposes.
5. Name the account something descriptive that includes the lender's name, for example, "Bank of America LOC" or "Chase Line of Credit." This clarity prevents confusion if you have multiple lines of credit.
6. Leave the opening balance at $0.00 unless you are setting up books for an existing business and already have a balance on the LOC. If that's the case, enter the balance as of your start date. Otherwise, always start from zero.
7. Click Save and Close.

You have now successfully created the liability account. It will appear on your Balance Sheet with a balance of $0 until you record your first draw.

How to Record Draws From Your Line of Credit

When you use your line of credit, you are increasing your liability. How you record this draw depends on what the funds were used for. Let’s cover the two most common scenarios.

Scenario 1: Funds Are Deposited into Your Checking Account

This is the most straightforward situation. The lender deposits a lump sum from your line of credit into your business checking account for you to use as cash.

To record this, you'll create a journal entry or a transfer:

• Go to + New in QuickBooks and select Journal Entry.
• Date the transaction for the day the funds were received.
• On the first line, select your checking account. Enter the amount of the draw in the Debits column. This increases your cash (asset).
• On the second line, select the Line of Credit liability account you just created. Enter the same amount in the Credits column. This increases the amount you owe (liability).
• Add a memo for clarity, such as "Draw from BofA LOC for operating cash."
• Click Save and Close.

After saving, if you look at your Balance Sheet, you'll see your Checking Account balance went up, and your Line of Credit liability balance went up by the same amount.

Scenario 2: The Line of Credit Pays a Vendor or Bill Directly

Sometimes, you might purchase an asset or pay a bill directly with your line of credit, and the cash never touches your checking account.

For example, let's say you bought $10,000 worth of new equipment from a vendor and paid for it directly from your LOC.

Here’s how to record it using a Journal Entry:

• Go to + New and select Journal Entry.
• On the first line, debit the appropriate asset or expense account. In our example, you would select an asset account like "Machinery and Equipment." Enter $10,000 in the Debits column.
• On the second line, credit your Line of Credit liability account. Enter $10,000 in the Credits column to show the increase in your debt.
• Add a memo explaining the transaction, like "Purchase of new lathe with Chase LOC."
• Click Save and Close.

Recording Payments to Your Line of Credit

Making payments on your LOC is a critical step to keep track of properly. Every payment includes interest (an expense) and principal (a liability reduction). You must split these two amounts for accurate bookkeeping.

First, ensure you have an Interest Expense account. Go to your Chart of Accounts and look for one. If you don’t have one, create a new "Expense" or "Other Expense" account named "Interest Expense."

Now, let’s record a payment of $800, where $650 is principal and $150 is interest, according to your lender's statement. The payment is made from your business checking account.

1. Go to + New and select Check or Expense (depending on how you paid).
2. Fill in the Payee (your lender's name), Payment Account (your checking account), and the Payment date. The total amount of the check/expense is $800.
3. In the Category details section, use two lines to split the payment:
   • Line 1: Select your Line of Credit liability account. In the amount column, enter the principal portion of the payment, which is $650. This entry reduces the liability balance you owe.
   • Line 2: Select your Interest Expense account. In the amount column, enter the interest portion of the payment, which is $150. This records the cost of borrowing as a business expense.
4. Double-check that the total of the two lines equals the total payment amount ($800).
5. Add a memo if needed, such as "Monthly LOC payment - May 2024."
6. Click Save and Close.

By splitting the transaction, you have successfully lowered your debt on the Balance Sheet and recorded the correct expense on your Profit & Loss statement.

The Final Step: Reconciling Your Line of Credit

To ensure total accuracy, you should reconcile your LOC liability account every month using the statement from your lender. This process confirms that your QuickBooks records match the bank's records, catching any discrepancies, missed payments, or bank errors.

Here’s the reconciliation process in brief:

1. Go to your Chart of Accounts and find the Line of Credit account. Click the dropdown arrow next to "View Register" and select Reconcile.
2. Select the Line of Credit account from the dropdown.
3. Enter the Ending balance and Ending date from your monthly lender statement.
4. Review the transactions. Check the box next to each draw and payment that appears on your statement.
5. As you check off items, QuickBooks will work toward a "Difference" of $0.00. Once you achieve a zero difference, congratulations! Your records match the bank's.
6. Click Finish now to complete the reconciliation.
7. If there's a difference, you'll need to investigate. Common culprits include a missed transaction, a payment entered with the wrong amount, or transposed numbers.

Final Thoughts

Setting up your line of credit as a liability, then carefully recording draws and split payments, is fundamental for maintaining an accurate balance sheet and profit & loss statement. By following these steps and reconciling your account monthly, you ensure your financial data is reliable for making key business decisions, applying for loans, and completing your tax filings.

Properly recording financial transactions is just one piece of the puzzle. When complex tax questions arise from these activities—such as the deductibility of interest or the tax implications of using funds for specific purchases—getting fast, reliable answers is critical. We built Feather AI for exactly that purpose. Our AI research assistant provides instant, citation-backed answers from authoritative tax sources, saving you time and ensuring you can confidently advise on the tax consequences of your client’s financing decisions.