Businesses commonly borrow money to improve their cash flow. Both short term and long term loans help to achieve this critical goal, but how do you know which is best for your business?
Understanding the differences between the two, and what forms they take, is the first step to empowering your business with positive cash flow and unlocking the benefits that come with it.
Both short term and long term loans help business cash flow. Long term loans are a great way to capitalise your business, but the cost and flexibility of short term loans make them better suited to the day to day needs of small businesses in particular. Invoice financing is a highly effective form of short term loan that is quick, easy and cheap.
What are short-term business loans?
Short term business loans can come in a few different forms. Common forms of short term commercial loans include:
- Bank overdraft
- Credit card
- Line of credit
Short term business loans improve small business cash flow by enabling them to pay suppliers, purchase inventory or cover expenses that businesses don’t have the cash for.
What are long-term business loans?
Long term business loans are those that take more than 3 years to pay off. Common types of long term loans include:
- Term loans
- Asset leasing
Long term business loans are often used to fund plant or equipment, and purchase vehicles or property. They are a good way to finance the stable, known and long-term funding requirements of your business.
The benefits of long-term vs. short-term business loans
The benefits of long term business loans compared to short term loans generally relate back to their maturity. Recognising these benefits helps to understand if your business needs a line of credit or a longer term finance solution.
Long term loans plainly come with longer maturities, which comes through in a few notable ways:
- Aligns with a long-term business strategy. It takes longer to realise the return on investment of a long term loan, but it enables a business to align its capital structure to its long term goals.
- Matches asset and liability lifespan. The lifespan of the assets financed by a long term loan matches the lifespan of the loan as a liability.
- Ongoing investor support. There’s more of an opportunity to grow a relationship with your long term loan provider because the relationship lasts longer. This helps them to better understand your business and your needs.
- Limited volatility. Long term loans tend to be at fixed interest rates, which limits your exposure to fluctuations that impact short term borrowing more.
- Diversified capital portfolio. Long term financing often has more flexibility to fund your various capital needs. It also reduces your dependence on a single source of capital.
Long-term vs short-term business loan financing
In assessing your borrowing structure, it helps to fully understand all the differences between short term and long term finance.
|Short term financing||Long term financing|
|Terms||Usually a revolving facility or terms less than 3 years||Minimum 3 years, often up to 25 years or more|
|Interest rate||Variable (higher)||Fixed (lower)|
|Uses||Working capital, expenses and other short term needs. For your day to day business needs.||Achieving long term goals, strategic initiatives or significant capital investments|
Short term loans vs. longer term bank loans for business: How to decide?
So how do you know which business finance option is best for your particular situation? It helps to analyse your own circumstances.
Establish your cash flow needs
How much money do you need on hand to pay for all the things you need to cover? Plainly, businesses need to be able to make their loan repayments, but you’ll also need a buffer too – if you don’t have anything left over after making the repayment, you may not be able to meet other expenses.
Paying bills late is never a good look, and can impact your credit score. Plus, it can result in more interest and late fees that ultimately end up costing you even more.
Having a basic, but realistic, cash flow forecast helps you to understand exactly how much you need. This includes other expenses, investment opportunities and business activity that all impact your cash flow.
Determine your risk tolerance
Every business, and business owner, has a different appetite for risk. There’s no ‘correct’ amount of risk a business should take on – it comes down to your own risk tolerance.
When it comes to business finance options, risk comes through in two key ways:
A long term business loan is riskier, because it takes longer to pay off. It’s usually a larger amount that sits on your books as a liability for a longer period of time. This is a greater obligation that requires more effort to meet. You need to be confident of your business performance at a consistent level over the term of your loan.
A short term business loan also has risk in that it can be less predictable. You’re more exposed to interest rate fluctuations, which can mean your repayment instalments can end up higher than when you first took out the loan.
Consider your current and future financial health
Crystal ball gazing is problematic, but the best you can do is make an educated guess about what your business needs are, both now and into the future.
This is another example of assessing risk. There may not be a perfect solution, but it’s about being able to recognise the totality of the different factors to figure out what’s best for you.
If you’re unsure about what cash flow will be like in the short term, then a long term loan can bring certainty. However, a longer term loan is a larger commitment to make, and if the business ultimately fails then you’ll have a greater responsibility to the lender.
Is your current financial position even strong enough to qualify for a long term loan? For many new businesses, it may not be. Short term lenders may be your only option for finance.
Conclusion: Utilise short term business financing with invoice discounting
If you’re still weighing up your options, there is a form of business financing that capitalises on the advantages of both long term and short term commercial finance.
It’s called invoice discounting.
Also known as invoice financing, it’s where businesses can get cash advances based on their invoices to help their cash flow. Invoice financing services such as FundTap effectively purchase business invoices, and the balance is repaid when the customer pays the invoice.
Read more: Tips for growing a successful business
It removes the liability that comes with any loan, and frees up money that can go towards expenses and investment opportunities that may not be possible with the current levels of cash.
It’s also cheaper, with no interest repayments and a single transparent fee, providing more flexibility than what lenders will offer.
With FundTap, businesses have the option to use invoice discounting only when they need to. If cash flow is good, then businesses aren’t penalised for not utilising invoice discounting. If it’s needed, then you can select only the invoices you want financed.
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