How to Use Short-Term Business Loans to Maximise Your Working Capital
When you need to increase your working capital and your credit card limits simply won’t cut it, you might consider short-term funding options like traditional loans. Many limited companies and other businesses use the short-term loan options offered by business banks to increase their spending abilities over a short period of time, and these types of loans often offer better terms than business credit cards. But, are short-term loans really the best options out there if you want to grow your business in a longer-term context?
What Are Short-Term Business Loans?
Short-term business loans are loans that banks offer business owners to improve their working capital over a relatively short period of time. To determine your eligibility for a short-term loan, a bank will carefully inspect your credit score and credit history to establish your ability to make monthly repayments.
In most cases, short-term business loans have repayment terms of a year or less. Some banks may offer early repayment bonuses if you pay back your loan early, but you’ll need to pursue a long-term business loan if you expect you’ll be incapable of paying back your loan within a year.
These conventional bank loans often involve costs like arrangement fees and loan application fees. Businesses generally pursue these types of loans when the projected costs of their business plans exceed their monthly turnover or annual turnover. Both vendors (suppliers) and customers (buyers) can benefit from short-term business loans; vendors can use these loans to make purchases while they wait for invoices to come in, and customers can use short-term business loans to pay their invoices.
Types of Short-Term Business Loans
Technically, any loan that lasts less than a year is an example of a short-term loan. In most contexts, however, this term refers to one of three basic types of short-term business loans:
1. Asset-Based Loans
Asset-based loans are any loans that a bank provides in exchange for temporary ownership rights to your assets. You can use either hard or soft assets to acquire asset-based loans. Examples of hard assets include cars, trucks, or any other types of equipment or inventory that have set market values and easy resale ability.
Soft assets are items of value with less set market values or assets that aren’t easy to resell. Examples of soft assets include invoices, inventory, or office equipment. Intangible assets are soft assets that aren’t even physical; examples of soft assets include software and intellectual property.
2. Lines of Credit
A line of credit, also called a revolving line of credit, is a credit line that a bank opens for you with a particular present limit. Lines of credit offer essentially the same benefits as credit cards, but they often have higher credit limits and lower interest rates. While most lines of credit are relatively long-term, it’s also possible to open a line of credit and close it within a year.
3. Invoice Financing
Invoice financing is technically a type of asset-based lending, but it is usually placed in a separate category. This type of financing involves selling your invoices to a bank in exchange for a portion of your invoice value, and there are two main kinds of invoice financing. You can use both types of invoice financing to finance a single invoice or your entire sales ledger, but there are a few relevant differences between these variations.
In an invoice factoring agreement, you sell your invoice to your bank along with credit control rights for the invoice. Therefore, when your client makes payment, he or she pays the bank instead of you. Most banks can offer approximately 80-85% of your invoice value in an invoice factoring agreement.
Invoice discounting agreements, however, don’t involve transferring credit control to your bank. Instead, your customers will continue to pay you directly as they always have. While the bank technically owns your invoices until they are paid, this type of invoice financing is more confidential, and you can usually get over 90% of your invoice value up front in an invoice discounting agreement.
How Do Short-Term Business Loans Work?
To help you get a thorough grasp of how short-term business loans operate, we’ll break the process down in simple steps. The same basic short-term loan process applies whether you’re a vendor or a customer.
- Determine your needs: Determine your exact working capital increase needs based on your monthly revenue versus your monthly costs.
- Contact your bank: You get in touch with a business loan officer at your bank. The loan officer floats a few different ideas that will provide you with the working capital you need. Depending on your credit score, credit history, and several other factors, you may not be eligible for certain kinds of loans.
- Determine your loan terms: You’ll need to work out the details of your loan terms with your bank. In some cases, you may have to offer assets as collateral. Examples of potential collateral assets include your invoices, your inventory, or your heavy machinery. Your bank will also determine the required repayment window at this time.
- Receive the designated amount: Your bank transfers the agreed-upon sum into your bank account.
- You make payments: There are a variety of different ways you might make a payment on your short-term loan. If you pursue invoice factoring or invoice discounting, for instance, your bank will receive the amount you owe when your customer makes payment. In other circumstances, you might repay the loan amount on a monthly basis or repay the full amount (plus interest) at the end of the loan window.
- You close out the loan: Once the bank has received full repayment of your loan, your bank will close out the loan. At this point, you can pursue another short-term loan if you so desire.
Real-World Example of a Short-Term Business Loan in Action
From both a vendor’s and a customer’s perspective, learn more about how short-term business loans work in the real world:
From a Vendor’s Perspective
You’re experiencing a cash flow crisis. Unpaid invoices keep piling up, which means you’re doing business but you aren’t getting paid for it. At the same time, you have overhead costs to pay, and you need to obtain the supplies you use to make products for your customers.
After talking things over with your bank, you decide to pursue a short-term business loan in which you offer the bank partial ownership rights over two of your heavy trucks in exchange for immediate cash. You receive a deposit of £25,000 in your bank account after signing paperwork that provides this financial institution with the required ownership rights.
To receive an annual percentage rate (APR) of 1.2%, you must repay your loan within six months. Your bank gives you the option of making monthly payments or paying off your entire loan at the end of the repayment window.
As your invoices start coming in, you become able to make monthly payments on your loan. At the end of your six-month term, you’ve paid back all the money you owe, and your bank returns the ownership rights to your heavy equipment.
From a Customer’s Perspective
You need to make purchases from your suppliers but haven’t made enough sales this month to cover your costs. You’ve already taken out as many invoices as you can, and your vendors don’t want to provide you with any more credit.
After talking with your bank, you reach an agreement in which you’ll give the bank ownership rights over e.g. 50% of your inventory in exchange for a £10,000 short-term loan. As soon as the bank transfers the funds to your account, you make the necessary purchases outright, and as a result, you grow your business at a far greater rate than you expected. You’re able to repay the loan within three months instead of six, and in exchange for this early repayment, you receive discounted interest.
Benefits of Short-Term Business Loans
Short-term business loans can ease some of the main stresses of running a business. Every business owner wants to stimulate the fastest-possible growth in his or her company, but cash flow concerns can threaten to ruin your momentum.
In many cases, buyers and suppliers can be flexible with invoice windows, but if you end up being unable to make the purchases you need to make with the usual forms of credit, short-term business loans can fill in the gaps and keep the ball rolling. In business, flexibility is one of the main keys to success, and short-term business loans provide you with the flexibility to achieve your growth goals, pay your employees, and make your business more competitive in your industry.
According to the time value of money theory, the money that you have today is more valuable than the money you will have tomorrow. The basis of this theory is that you can use the capital you have right now to make purchases that will stimulate the growth of your business. If you consider point A to be right now and point B to be 30 days in the future, when you receive money at point A instead of at point B, by the time you arrive at point B, your business will have grown significantly more. Short-term loans allow you to exploit this principle relatively efficiently.
Pros and Cons of Short-Term Business Loans
To sum it all up, here are the major pros and cons of taking out short-term business loans as a vendor or as a customer:
- Provide you with the money you need to grow your business today instead of later.
- Generally, have lower interest rates and better terms than credit cards.
- Have higher credit limits than credit cards.
- You can usually get a collateral-backed short-term business loan even if you have subpar credit.
- While these business loans are short-term, they require lengthy application processes.
- Depending on your credit history, short-term business loans might not have significantly better interest rates than credit cards.
- You often have to give up ownership rights to assets to secure short-term business loans.
- These types of loans almost always involve personal guarantees or other forms of recourse.
Short-Term Business Loans and CreditDigital
Short-term loans are undeniably convenient if you want to grow your business. However, these types of loans can become annoying fast when you have to deal with lots of paperwork or extensive application processes. What if you could have all the best aspects of short-term loans without the high interest rates and personal guarantees?
Here at CreditDigital, we offer an innovative business finance solution that does away with all the annoyances of short-term loans for both vendors and customers. Whether you want business credit to free up the cash flow that’s currently tied up in unpaid invoices or you want to make purchases without worrying about depleting your working capital reserves, CreditDigital has a solution for you.
When you’re trying to grow your supply business, waiting for delinquent customers to pay their invoices can stop your plans dead in the water. With CreditDigital, however, you receive 100% of your invoice value up front without having to worry about personal guarantees or any other form of recourse. Instead of agreeing to exploitative loan terms or taking a mere portion of the money you’re owed with invoice factoring or invoice discounting, work with CreditDigital to receive all the cash you need to grow your business today.
As a small business customer, you’re always trying to make ends meet as you chase your dreams. Having to pay up front for the supplies you need forces you to make tough decisions, and watching unpaid invoices pile up can cause stress that you simply don’t need in your professional life. You can use CreditDigital, however, to take care of unpaid invoices in an instant and keep relations with your vendors friendly and productive. CreditDigital will always be there when you need to make purchases in the future; with 0% interest payment plans and up to 12 months to pay your invoices, any loan amount up to £250,000 will be a walk in the park.
Never worry about the higher interest rates imposed by traditional banks ever again. Here at CreditDigital, we’re standing by to provide you with the business funding you need to grow your company no matter what your needs may be.
As you learn more about the benefits and detractors of short-term business loans, you might come across some of the following terms:
A commercial loan is the same thing as a short-term business loan. However, the term “commercial loan” is more commonly used to refer to larger loans taken out by big limited companies or corporations.
Working Capital Loan
You may hear short-term business loans referred to as “working capital loans.” Professionals in the financial sector use this term to refer specifically to loans that businesses use over a brief period of time to generate working capital during slow periods or while they have large numbers of outstanding invoices.
An unsecured loan is a loan that an individual or a business takes out without any collateral. These types of loans usually have higher interest rates than secured loans.
“Asset financing” is sometimes used to refer to a situation in which a company uses existing assets, such as balance sheets or inventory, to receive working capital on a short-term basis. However, finance professionals also used this term to refer to a type of financing a business uses to purchase an expensive asset. Until the business reaches a certain amount of equity in the purchased asset, which might be a piece of heavy equipment like a truck or a forklift, the asset technically belongs to the bank even though the business can use it.