Running a business is hard. Despite having a lot of savings, you will find yourself with cash flow problems in the beginning years. No matter how good planning you have done, you cannot get an accurate need of money until you dive in. A business takes several months to hit the breakeven point, so, in the interim, you will mostly have to rely on your own sources. However, as your business starts flourishing, you will need more money.
When it comes to funding a business, you can consider short-term and long-term business loans. You might wonder which loans are suitable for you. It depends on your business purpose and various other factors. Before that, you need to understand what short-term and long-term business loans are.
Short-term vs long-term business loans
Short-term business loans are aimed at funding temporary cash-flow gaps. The typical repayment period of these loans is up to 12 months. The most common reasons for using these loans include:
- Inventory purchase
- Emergency repairs
- Any other unexpected expenses
The unique selling point of short-term business loans is that they are quickly processed, and hence, they are called instant short-term business loans, too. Short-term business loans usually carry higher interest rates because they are not subject to any collateral. The timeframe is small, so the amount of the monthly instalments will be bigger.
Long-term business loans aim at funding long-term investment plans. For instance, you want to buy a space for your office. The repayment period of these loans can be up to five years or more.
Long-term business loans carry relatively lower interest rates because lenders do have a chance to repossess the collateral you put down while borrowing money. Apart from a lower interest rate, you will be paying off the debt in smaller monthly instalments. It will make payments manageable.
Getting approval for a long-term business loan is not a cinch because you will need a good credit score and business credibility. If your business has a separate legal entity, your lender will look over your business credit rating, too. The process of applying for these loans is quite complicated and lengthy, even if you apply for them online.
Ways to choose the right loan
It can be quite difficult to choose between short-term and long-term business loans, but there are some ways to help you make your decision easily.
- The purpose of the loan
The purpose why you are taking out a loan plays a crucial role in deciding which one suits you best. For instance, if you are looking to fund temporary cash flow gaps, short-term business loans are a good choice. There is no point in borrowing more than you need and tying yourself to a long-term repayment plan.
However, when you are planning to purchase equipment or expand your business, you will need a long-term business loan. Bear in mind the reason why you want to use the loan while borrowing money. Short-term and long-term loans are used for different reasons.
- Repayment capacity
Sometimes, you have the right to choose between a shorter and a longer repayment plan. For instance, if you take out a loan to buy equipment that you are to pay back over a period of 18 months, you can choose a two-year repayment plan. It depends on your repaying capacity. If your business is struggling with cash flow, you will certainly want to opt for smaller monthly instalments.
However, choosing a longer repayment plan means that interest payment will be more in total. You should choose a longer repayment plan only when you have serious cash flow problems. A long-term commitment is quite risky because you can lose the collateral in case you do not pay back the debt on time.
- The cost of financing
It is vital to consider the cost of financing. It does not just include the interest rates but also includes fees and other charges. Short-term business loans carry high annual rates. This means that interest rates and associated fees are quite high compared to long-term business loans in the UK, but despite that, they may cost you less money in total interest.
It is quite hard to choose a loan based on the cost of financing, but keep in mind that you should never choose a longer repayment plan when you can manage to pay high monthly instalments. You should always try to figure out ways to save your money. as far as it is about interest rates, make sure to do proper research. Because interest rates vary by lender, intensive research can help you choose a lender who charges relatively lower interest rates.
- The impact on cash flow
Loan payments have a great effect on cash flow. Of course, when a larger payment goes towards the debt every month, you will be left with little cash. It can make it complicated for your business to smoothly manage operations. In this situation, choosing smaller monthly instalments sounds great, but their impact on your cash flow will be in the long run.
You should carefully analyse the impact of a loan on your cash flow before arriving at any decision. You should have an alternative repayment plan because it will help you keep up with payments when your business struggles to make profits.
The bottom line
It depends on your business needs whether you will use short-term or long-term business loans, but while borrowing money, make sure you carefully analyse whether the lender you have picked charges affordable interest rates.
