As a small business owner, you know how important it is to have immediate access to funds. A new opportunity that could boost your company’s profits may suddenly arise. But it may require a substantial investment. Short term business loans or credit cards may be viable financing options to fund these opportunities.
Quick Access to Capital Matters
Consider a situation where you get a chance to buy inventory at rock-bottom rates. Or, you may need cash for a new set of marketing initiatives. The immediate cost of participating in a trade show or publishing a series of advertisements in the local paper could be high, but you are convinced that in the long term, it will provide your firm with a large payback.
How will you raise as soon as possible the money that your business needs?
Two sources of business funding that many entrepreneurs turn to are short term business loans and credit cards. Both can be excellent sources of business credit. But you must remember that these two financing options have very different features. If you understand how short term business loans and credit cards work, and use them in the correct manner, your business could gain tremendously.
However, using an inappropriate source of finance could result in inflated interest costs, lower profitability, and possibly, a decrease in your credit score.
Let’s understand the features of these financing options and see how they can be used to provide the greatest possible advantage to your business.
Short Term Business Loans
What is a short term business loan?
A short term business loan is a type of lending agreement that can provide your company with quick working capital. What makes short term loan different is that they have a shorter payback period: usually, one year or less.
How do short term business loans work?
Like most loans, you’ll receive a lump sum of cash upfront which is repaid to your lender over a set period of time (plus interest and any fees): usually within one year. However, most short term loans are repaid even more quickly -within 90-120 days.
This financial product is a favorite with businesspersons who want to raise cash quickly and at reasonable interest rates. Short term business loans typically cost between 1% per month to 2.5% per month. Repayment could be made in monthly payments over a period that ranges from 24 months to 60 months.
Do banks give short term loans?
Yes. There’s a variety of lenders that offer short term loans: banks, online lenders and credit unions. They will vary in loan amounts, interest rates and payback periods.
Pros of short term business loans
One advantage of a short term business loan is that lenders usually offer a quick turnaround. In fact, it is possible to complete a significant portion of the loan application process online. This is both fast and convenient, and you don’t even need to visit the lender’s office. However, you should ensure that you take the basic precautions that are necessary to protect yourself from online fraud.
Why would a business take out a short term loan?
When is a short term business loan a good idea? When should you consider using a short term business loan? If your needs match the following criteria, small business loans of this type may be among the most suitable loan options.
- You need a lump sum of cash quickly: A short term business loan can provide you with the money that you need to take advantage of a new business opportunity. It is a type of term financing that is repayable over a fixed period.
- You don’t want a loan that carries confusing terms and conditions: You’re the type of person who likes to understand the exact nature of what you agree to before you sign on the dotted line. In this way, short term loans are easy to get. You can learn here more about the so-called “easy business loans“.
- You want to be sure that you can meet your repayment commitments: A short term business loan will ensure that you don’t get any unpleasant surprises. Right from day one, you will know exactly how much you need to repay every month. You will also be aware of the precise number of months for which your repayment will continue.
Small business owners are often confused about the amount of money that they should borrow. The fundamental principle here is that your loan amount should not exceed a sum that you cannot easily repay. To put it another way, you should be very sure that you can afford the monthly installment that you are committing to.
One precaution that you can take is to maintain a cushion. If you are sure that you can pay $1,000 every month to the lender, limit your monthly installment to a little less, say, $800, in other words, limit this amount to 80% of what you can really afford. It may also be a good idea to extend the loan period. This will lead to lower monthly installments and will help minimize the chance of default.
If you find it confusing to estimate the repayment amount for various loan amounts and payment periods, you can use this handy Small Business Loan Calculator.
How will you know if you are eligible for a short term business loan? Here’s a brief description of some of the conditions that you may be asked to meet.
Some requirements to apply for a business short term business loan
- Your business should have been in existence for a minimum of nine months. A year or more is better.
- Your revenues should be at least $30,000 or more annually.
- Be current on all existing debt payments and no reported bankruptcies in the past 12 months.
Business Credit Cards
It’s crucial to remember that the funds that you access through a business credit card should usually not be used in the same manner as the money from a short term business loan. A credit card is similar to a line of credit. You can draw upon it when the need arises and repay when you have the liquidity. It’s one of the best ways to meet the cash flow gaps in your business.
This flexibility is one of its greatest advantages. The money is available to you when you want, and you pay interest only for the period for which you use the funds that you borrow.
But you must bear in mind that the benefits that a credit card carries come at a cost. Although rates may vary, you should expect to pay a significantly higher rate of interest on your credit card outstanding balance as compared to the interest cost of a short term business loan.
How much can you expect to pay on your outstanding credit card balance? A recent article in Forbes by Diana Hembree, a journalist who covers consumer protection and fraud, points out that if you have a low credit score, your yearly interest rate on your business credit card could be 29% or even more.
So, under which circumstances does it make sense to use your credit card? Here are several expenses that you can use your card for. In fact, it could be advisable to maximize your card usage (as long as you don’t incur additional interest costs) because you could earn reward points as well as cashback amounts.
Dos and Don’ts of Business Credit Cards
- DO use your credit card if you are sure that you can repay before the next due date.
- DO use your card for emergency cash. While the cost could be high, at least you will be able to meet your financial obligations. However, if you need to use this feature regularly, you should look for a lower cost long-term financing option.
But DON’T use your credit card for:
- Buying capital assets like machinery or equipment. If you do this, it is highly likely that most of your profits will be eaten up by the credit card interest cost.
- Any amount that you can’t afford to pay by the next statement date. You should also remember that if your credit card outstanding balance exceeds 30% of your credit limit, it could affect your credit score.
Another problem with credit cards is that you may be required to pay several types of fees. These include annual fees, cash advance fees, late payment fees, and over-limit fees. Additionally, the interest rate that you pay on your outstanding balance may be linked to the prime rate. This could result in your rate changing every time that the prime rate changes.
So, which is more beneficial for my business?
If you want to repay the money that you borrow over a period of two years to five years, a short term business loan wins hands down. Business loans have other advantages too. They are generally a less expensive form of borrowing than credit cards. Additionally, your repayment amount and the repayment period are fixed. This can make it easy to plan your cash flow and estimate your liquidity requirements.
Credit cards also carry their share of benefits. They can provide you with emergency cash that can help to get you through a lean period. But don’t forget that this is a high-cost option that should be used only when it is necessary.
At Camino we want you to be aware of all your options. If you are doubtful whether you should apply for a short term business loan or get a credit card, we invite you to keep reading Business Credit Cards vs. Camino Financial Business Loans to check for yourself why a loan from Camino may be the best option for your business.