Businesses use short-term loans in various ways, mostly to plug dips in cash flow, navigate seasonal variations, and fund company development and growth. Understanding short-term loans can help your business better take advantage of them and identify when to best use such funding options.
This guide provides a comprehensive overview of short-term loans and how your business can use them as an essential tool for companies looking for fast access to funds.
What is a Short-Term Business Loan?
Short-term loans enable business owners to borrow and repay essential finances within months. Compared to long-term loan options, short-term loans are generally easier to acquire and process within a shorter period.
At Key Factors, we offer Invoice Discounting, Debt Factoring, Invoice Financing, Debtor Financing and Cash Flow Finance.
Short-term loans also have shorter application processes and, depending on the lender can sometimes have faster approval periods. However, because they are short-term, they generally attract higher interest rates.
What Can You Use Short-term Business Loans For?
Short-term loans have various applications in the business world, such as the following:
- Navigating seasonal variations for seasonal businesses.
- Managing cash flow
- Smoothing out financial emergencies
- Paying for broken equipment
- Capitalising on time-sensitive offers extended by a supplier
- Buy stock or inventory
- Purchase of essential tools
- Acquiring property
Key Features of Short-term Business Loans
Short-term business loans have various features that distinguish them from long-term loans. The most basic of these are the shorter repayment period and higher interest rates, a faster approval process, and small amounts.
Short-term loans can be secured or unsecured. Business owners can also be requested to provide a personal guarantee. It’s not uncommon for these loans to have no specific purpose, while others are extended to satisfy specific business needs, such as purchasing inventory.
Types of Short-term Business Loans
Businesses have several types of short-term business loans from which they can choose. The ideal type varies depending on the options available to them and their needs. Some of the available options for short-term business loans include:
Term Loans
These are the most commonly used types of short-term business loans. A term loan is when a lender extends a sum of money to the borrower, and the borrower repays the loan with regular payments over a fixed period. This type of loan is easy to access and provides the business with quick access to funding.
Line of Credit
This is another form of short-term loan. Line of credit loans include business credit cards. They are a pre-approved sum that the borrower can draw from and replace, usually within a period not exceeding one month. Then, you can borrow again and repay within a month. These can also be referred to as revolving credit facilities.
Merchant Cash Advance
A merchant cash advance is an advance on future card sales. You receive a lump sum in exchange for a percentage of future earnings, and you pay the same back as a percentage of your weekly or monthly card sales until the full advance is repaid, plus the interest and any relevant fees.
Invoice Finance
Technically, invoice financing is not a loan because you don’t pay back the money, but it is a way to release cash tied up in unpaid invoices within a short time. With invoice financing, you sell your unpaid invoices to a third party that purchases the invoices at a discounted rate, giving you instant access to funds while the invoice company follows up on payments with your clients.
Equipment Financing
This involves leasing or buying a piece of equipment. It can take many forms, including monthly repayments, taking on full ownership of the equipment at the end, and even trading up at the end of the term.
Bridging Loans
This type of loan is designed to bridge the gap between funding. It is often used to acquire property while awaiting additional funding, for instance, in the form of a commercial mortgage or the sale of a different property. Interest is usually spread over a series of monthly payments, up to around 12 monthly payments, with the full amount repaid at the end of the term.
Benefits of Short-term Business Loans
Opting for business loans can have various benefits, including the following:
Fast Access
Short-term loans are easy to access. They are designed to help in emergency circumstances and are, therefore, readily available and faster to facilitate.
Flexibility
There is a wide range of short-term business loan types for businesses to choose from, covering a wide range of uses, including property purchase and stock acquisition.
Accessibility
There are many lenders and lender types in the short-term business loan space. These include business banks, online lenders and credit companies. The diversity of lenders makes short-term loans a more accessible form of funding for businesses.
Shorter Payment Terms
When you need some cash for a specific period and then want to close the agreement, short-term loans can be an excellent option. Long-term loans make it difficult to terminate the agreement because of the early repayment fees.
Potential Risks of a Short-term Business Loan
While short-term business loans are popular among businesses, they come with some potential risks that businesses should be aware of before taking out this type of loan.
High Interest Rates
The way short-term loans are designed makes them riskier for lenders, as the borrower has less time to meet the repayment terms. This means short-term financing often comes with higher interest rates. The business should carefully consider these interests and be sure that it can make the payments on time to avoid additional penalties and fines.
Smaller Loan Amounts
Short-term business loans are only ideal when you’re looking for small amounts. Because there is less time to repay the loan, lenders may be less inclined to offer large amounts. If you’re looking for a large loan, you should consider long-term loans that will also offer more favourable terms.
Credit Score
Missed repayments and defaults will negatively impact your personal and business credit score, which will affect your ability to borrow in the future.
Debt Trap
Short-term loans can create a cycle of debt in which the borrower consistently borrows funds beyond their means to repay and then relies on new debt to repay the historic debt.
Conclusion
Businesses need to remember that the benefits of short-term loans and the potential pitfalls depend on the lender as well. Some lenders offer better terms, while others have more stringent requirements. Ultimately, businesses should thoroughly assess their short-term loan needs, carefully weigh the benefits and risks, and ensure they have the capacity to repay before committing to any loan.
