When it comes to financing your business needs, you may be considering two popular options: A business loan or a business line of credit.
Small business loans and lines of credit have some important similarities. They both offer businesses the opportunity to leverage existing assets in exchange for liquid capital. This capital can be spent on a variety of relevant operational needs.
However, there are some important differences between small business loans and lines of credit. Understanding how a loan and small business line of credit differ can help you make the right choice when deciding how to finance your business.
Small Business Loans
A small business loan is, in general terms, a fixed amount of money provided by a financial institution to a business. Many small business loans are offered in smaller amounts than large commercial loans to give small businesses a better chance to pay the loan back. You can use the loan funds for almost any aspect to operate your business.
The concept behind a small business loan is simple. A business owner requests the loan through a loan application. If approved, most lenders fund the entire loan amount requested by the business owner.
The borrowed money is paid back over time. Most business loans are paid in monthly increments. Interest is charged on the remaining balance of the loan and added to the monthly payment.
Small business loans may seem hard to get. After all, traditional lenders tend to avoid lending to small businesses. Most lenders feel more confident working with larger, established businesses with long histories.
Alternative lenders can make it easy to get approved. Requirements are usually simple and already met by many companies. Consider these common reasons for requesting a small business loan:
Whether new or old, many small companies eventually want to increase their presence. As a business owner, you do your due diligence to research your desired market. You notice a need from a new market that your business can provide. This could potentially increase your revenue and market share. However, you need capital to fund your expansion efforts and don’t have the cash immediately available to pay for the expansion.
A small business loan addresses this issue, giving your business an infusion of cash. You can use the funds to make your dream of moving to a new facility or extensive purchasing of new equipment a reality. It can also address needs that are required for expansion but don’t provide an immediate return on investment.
Increased payroll, for example, allows you to hire and train the new employees you need for a second location. You won’t be able to recoup the expense of training a full new staff for some time, so a business loan helps pay for the upfront cost. This boost in available funds can mean the difference between a developing small organization and a stagnant one.
Addressing Unexpected Financial Obligations
Constantly and effectively managing cash flow is a difficult proposition for many small enterprises. Cash flow management requires you to consider your current actual cash assets while also addressing revenue and profit. Your business may perform very strongly month after month, but the timing of tax bills, payments to vendors and other considerations can fall close together and create problematic cash shortages.
With a small business loan, you can avoid the crunch that lots of bills and other obligations create for your available, short-term cash reserves. The loan allows you to address these urgent requirements for payment, while your long-term revenue will help pay it back in a more manageable and predictable way.
Your current business goals may be improving efficiency, effectiveness or other results within your current framework. Whether it means replacing existing equipment, giving the customer-facing areas of your facility an upgrade or something else entirely, improving an area of operations is eventually a need for all businesses.
In this case, a small business loan allows your organization to address the exceptional price tag frequently associated with making improvements. You’ll be able to pay back the cost of the renovation or upgrades over time instead of upfront.
Line of Credit
Loans are a common tool for business owners. However, a line of credit is even more common than a loan. If you’ve ever had a credit card in your own name or that of your company, you’ve used a line of credit.
A business line of credit is significantly different from a loan because of its revolving nature. While a loan usually involves a single, defined amount of money, a business line of credit for small businesses can be replenished up to the credit limit over and over again. As long as you continue to make the minimum payment on time, your business has access to the available amount of credit.
Over months and years, credit lines prove to be significantly different from a loan. Loans generally have a fixed term, while lines of credit can be used as long as minimum payment requirements are met and a business desires to continue their use.
Because a business line of credit continues to exist, and the credit limit is often lower than the amount provided by a small business loan, its application is sometimes different than a loan.
You can use it to address many of the same needs as you would use a business loan. However, you may find it’s more difficult to fund large expenses with a line of credit, thanks to a frequently lower amount of funds available. A small business line of credit can also be used for smaller and more regular expenses and to smooth over continuing iusses with cash flow.
Choose the Best Solution for Your Business
Both small business loans and lines of credit have important applications in the world of business. Understanding the differences between them helps your company make the best possible decision for its future.