Both revolving credit and business loans make sense to use for short-term and immediate expenses, as well as purchases and repairs when it comes to your business. There are specific situations where one is better than the other, even when the issue is similar.
A piece of equipment breaking during a busy season is a good example. If the repair is something that you can recoup the cost of quickly, revolving credit is a good option if you’ve already been approved or using a credit line. This is because you don’t have to re-apply for access to funding, like you would with a brand-new business loan that does a hard inquiry and typically requires payments over a longer period.
If the repair person is not available for at least a month or parts won’t be available for a few months, a small business loan in the form of equipment financing may be better. You’ll be able to purchase or lease new equipment to keep your business functioning and sell the damaged equipment or simply have bandwidth to wait until it can be repaired.
If you’re stuck choosing between revolving credit and business loans, don’t stress. Below you’ll learn about what both are, the similarities and differences, and then you’ll learn about situations where one is better than the other.
Revolving Credit
Revolving credit is a type of debt financing where you are approved for a sum of money that you can borrow at will, and it replenishes as you pay it back. This includes credit cards, lines of credit, CAPlines, and any other type of financing that replenishes as it is paid.
Revolving credit can include annual fees, interest fees if you carry a balance, and usage fees depending on the type. It can have a negative impact on your business and personal credit scores if you do not make payments on time, and if a hard inquiry is made when applying. Most types are reported to credit bureaus, which can have both positive and negative impacts on your credit utilization ratio—a key factor in determining your business credit score.
Revolving credit is a good financing choice when you have expenses that can be paid back quickly before interest kicks in, or that will cost less with a few interest payments compared to a business loan, which could require 6 months to 3 years of payments. It also makes sense when you don’t have time to apply for a business loan, or when the amount is not high enough to justify the interest payments or the length of time you’ll be carrying the debt.
Business Loans
Business loans are a type of debt financing where a company borrows money from a lender and makes payments with interest on a fixed schedule that is outlined in the loan agreement. Business loans can be short-term loans, meaning under three years, or long-term which can be three to 10 years on average, with some SBA loans for real estate lasting 25 years.
There are multiple types of business loans with each being designed for specific purposes like equipment financing to buy or lease new and used equipment, working capital loans to cover operating costs, and inventory financing to stock up for a busy season or keep up with demand.
Business loans are a good financing solution when you won’t be able to pay the debt back before the first interest payment is due, when you want to spread the expense over a longer period of time, or when you need to make larger purchases.
How They’re Similar and Different
While both revolving credit and business loans are types of debt financing and can require interest payments, they have a few differences.
|
|
Revolving Credit |
Business Loans |
|
Replenishes |
Yes |
No, you need to re-apply |
|
Large or smaller expenses |
Smaller |
Larger |
|
For short- or long-term usage |
Short-term usage |
Long-term usage |
|
Interest payments |
Higher and only when you carry a balance |
Lower and are applied to all payments on the schedule |
|
Fees that may be applied |
Annual fees, origination fees, withdrawal fees, maintenance fees, utilization fees, and when the borrower exceeds the limit or does not make payments on time |
Origination fees, application fees, curtailment penalties, late fees on payments, closing costs |
|
Payments |
Minimum monthly payments or agreed-upon term payments |
Fixed payments on a schedule |
Situations to Use Either Revolving Credit or Business Loans
While these two types of financing are very similar, they don’t always work the same based on your situation. Here are a few times you’ll need to choose between revolving credit versus a business loan, and which to go with.
Utilities and Monthly Expenses
Utilities including electricity and water, or monthly expenses like rent, warehousing, software subscriptions, and janitorial services can be covered by either one. It comes down to how much you need, the options available to make payments, and if you’ll need to keep cash reserves freed up.
Credit cards can be used to cover most of these and be added to service providers for automatic payments, so if your monthly expenses are minimal and you make credit card payments before a balance becomes due, revolving credit is perfect.
A business loan makes more sense than a credit card if your card is going to be needed for a sizable purchase, or you need to keep cash reserves and emergency funds clear. If you’re covering the costs of point-of-sale equipment software but also need to replace or upgrade equipment, a business loan can make more sense.
The business loan lets you pay a lower interest rate and spreads payments across a longer period while you recover the costs via the new equipment. Having your revolving credit available gives you a safety net for unexpected emergencies.
Vehicles, Machinery, and Equipment
If you only need to repair a machine or a vehicle, revolving credit is likely your best bet. The costs are not high enough to justify a business loan, and you don’t have to wait for approval if you already have access to a line of credit or a credit card. If the vehicles or machinery are not operational but vital, each day they’re not running costs you money, so having the immediate access to cash flow via revolving credit makes sense.
When the equipment, machinery, or vehicles need replacing and you don’t have the cash flow to buy them outright, a business loan in the form of equipment financing is the better option. The equipment and vehicles can likely be used as collateral and you’ll be spreading the costs over a longer time period with a lower interest rate than revolving credit. This gives you time to make your money back.
If you need to rent equipment or vehicles for a project, both can be a good option. If you recover the money each month and the rental is short term, go with revolving credit. When you have to wait for accounts receivable after the project is completed or the money won’t be recovered immediately, a business loan is the better choice as you’ll have a lower interest rate while you wait for funds to come in.
Business Expansions
Growing your existing company by increasing production or adding additional locations can happen with both business loans and revolving credit.
A business loan is better than revolving credit for opportunities that require a larger amount of money, like opening a second location and needing capital for a new lease, inventory, equipment, and furniture. It can also be used for training, licensing, and any permits that are required. You’ll be making lower fixed payments compared to if you would carry a balance with higher interest via revolving credit. This allows you to get profitable over a longer period of time with less strain on your finances.
Revolving credit can be perfect for covering smaller amounts like making payroll, securing inventory that you need quickly when there’s no time to apply for a loan, and other short-term expenses that you’ll recover quickly. If the freezer at the location goes out, a business credit card or business line of credit lets you restock it that same day, and you’ll begin recovering the costs as the food is cooked and served, helping you make the payment before a balance comes due.
Both revolving credit and business loans are good for short- and long-term expenses, but revolving credit is better when you’ll pay the balance off quickly or before interest on the balance is due, and business loans are better when you need larger amounts of financing and over longer periods of time.
National Funding does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
