What happens if your business isn’t eligible for a credit line from a bank?
You might be lucky and obtain a short term loan to finance your interim working capital needs.
While they are easier to acquire than their traditional equivalents, you should be aware of the negatives.
What is a Short Term Business Loan?
If you are looking for fast cash for your business, you can apply for a short term business loan.
While large banks offer traditional loans, entrepreneurs can get short term loans from lenders like credit unions and smaller banks.
They are usually easier to obtain, but the term will be shorter than a traditional bank loan.
Interest Rates for Short Term Business Loans
Financial institutions use the prime interest rate and add on a premium founded on the degree of risk associated with the company.
When the economy moves into a recession, short term interest rates tend to drop.
Let’s say you want to borrow $50,000.
You need this capital for one month, and you are told you will be charged 3%.
In the majority of cases, this will be 3% per month.
If you borrow $50,000 for a month, you will have to pay back $51,500 (principal $50,000 plus $1,500 interest).
Typical interest rates range from 6 – 13%.
| Interest Rate | Profitable Yrs. in business | Personal Credit Score | Size of Loan |
| 6 %(lowest) | more than 3 years | 800 to 850 | More than $350,000 |
| 9.5 %(median) | 2 to 3 years | 700 to 800 | $100,000 to $350,000 |
| 13 %(highest) | 2 years | 660 to 700 | $100,000 |
Pros and Cons of Short Term Business Loans
Pros
As a business owner, you sometimes need access to working capital quicker than a traditional bank loan can offer.
There are many short-term financial options available, but the belief is they are dangerous and should be avoided.
Not all short-term business loans are the same.
However, be prepared to research, read the fine print, and be aware of what you are getting into and borrow responsibly.
The result could be a great future for your business.
It is unlikely that you will be given a long-term loan if:
- You have only been in business for a short period.
- You have a poor credit history.
- You have low annual revenue.
There are many different kinds of short-term loans available.
Many accept borrowers with minimum business experience or a low credit score.
The approval procedure for short-term loans usually takes place online.
You can apply for funding anytime and anywhere.
There is limited paperwork which means less time preparing your loan application.
In the long term, your company may be debt free, and the loan will usually mature within a year.
You will also be more responsible with your savings as this is a limited funding source.
If you need to take out a new loan at a reduced interest rate, your credit score will have increased as the loan must be repaid in the short term.
Cons
A higher approval rate also comes with a much higher interest rate.
The lender will be taking on more risk by accepting a less than perfect borrower.
This means that you will be paying much more over time than you would if you had a long-term loan.
Also, the terms of the short-term loan might include a stipulation that payments are made on a daily or weekly basis.
If you are looking for capital because your business is going through a rough patch, this could be a problem.
Taking on a short-term loan can reduce your access to other types of debt financing during the loan term.
Remember this if you intend to apply for a more substantial long-term investment in the immediate future.
You need to decide whether quick access to cash is worth the limitations.
Best Ways to Use a Short Term Business Loan
If you have cash flow shortages due to uneven or cyclical sales structures, a short-term loan may be an ideal solution.
Many new businesses find it challenging to finance supplier bills and other expenses.
Short term loans can also assist your company pays future taxes.
Short-term loans will help your business to survive seasonal trends.
Many companies need extra capital and staff during the holiday season.
You will be able to cover temporary worker’s wages and build up inventory to prepare for the holiday rush.
You can finance an expansion with a short-term business loan.
You may want to expand your service or product line, purchase new equipment, or open a second store.
You will need upfront capital to develop, and short-term loans can provide that money.
You may have good business insurance, but sometimes you’ll find yourself in an emergency.
Acquiring a short-term loan will prevent your business from going under if something arises like a natural disaster, equipment breakdown, or computer crash.
Before You Settle on A Short Term Loan
Read the Fine Print
When it comes to your business, you should always study the fine print.
Take particular note of requirements for a personal guarantee or collateral, as well as how the interest rate is listed.
These can have a long-term effect on your business.
Make a Payment Plan
Before you sign for a short-term loan, make a plan.
- What can you afford?
- How will you pay it back?
- How much is the loan going to cost?
Know What You Can Afford
To work out what you can afford, you need the debt service coverage rate (DSCR) formula.
- Calculate the monthly cash flow (average monthly revenue minus your average monthly expenses)
- Divide that by the total monthly cost of your prospective loan.
- If the loan has daily or weekly reimbursements, add all the payments together.
- The higher the number is over ten, the more affordable the loan will be.
Clarify Repayment Schedule
Cash flow can be significantly affected by whether the loan is repaid on a monthly or daily basis.
It will depend on how expenses and revenue flow within your business.
A short-term loan with daily or weekly repayments will compound interest more quickly, thus accelerating the total cost of borrowing.
You need to examine how and when interest compounds, as well as the repayment schedule.
To assess the effect you can draft a cash flow forecast or a loan amortization.
Short term business loans are essential for businesses and the economy.
They can save a company in times of emergencies.
They cover working capital shortages.
And they help business owners grow and expand their customer base or operations.
Seasonal businesses of all sizes often need a short-term loan to include the need for extra capital and staff.
Businesses like restaurants which have cash regularly coming in will be able to comply with the repayment terms better than other companies with an irregular cash flow.
Short term loans are more accessible to apply for, but the interest rates are higher than other investments.
You should do your homework before applying for a short-term loan and read the fine print.
As long as you follow these rules, you should be able to use a short term business loan to your advantage.
Questions? Call Joe Schuck: VP of Sales
813.734.7176