Many different situations can prompt small businesses—even well established ones—to consider applying for a short-term loan. The popularity of this financial product has steadily been on the rise—between 2012 and 2013, the amount of short-term credit loaned by non-bank lenders doubled from nearly £1.1 billion to just over £2.1 billion.
But what exactly does this mean for small businesses? Much like its other financial counterparts, a short-term loan has its own pros and cons and doesn’t suit every scenario. In some cases, it can even be harmful. Small Business Advice Week has a few tips that will help you determine when to go for this option.
1) What is a short-term loan?
A short-term loan is traditionally interpreted as a quick infusion of capital that is repaid over a year or less. While this type of finance can serve a range of purposes, its most common use historically has been to tide businesses over when they’re experiencing a drop in revenue.
However, Philip Hargreaves, Head of Access to Finance, claims that the growth of the alternative lending industry is changing the game. “Fintech and alternative finance is supporting the maturity of the short-term industry,” Philip says. “Short-term lending has grown up from simply being a bridging loan.”
Businesses are now turning away from the idea that short-term finance is the option only when sales are low. The new scenario, according to Philip, is when businesses are experiencing rapid growth.
“There’s a conception that if a business has short-term cash needs, it’s in trouble,” he explains. “Of course, while this is true in some cases, a lot of small businesses are looking for capital injections to manage fast growth or to finance a business opportunity.”
2) How can a short-term loan help your business?
Before applying for any kind of finance, it’s important to work out the reason for the loan, as well as how this addresses your business needs in the long term.
“Short-term loans suit growing businesses that need an immediate boost of cash. These businesses may need more working capital to gear up towards a new contract, or to take on additional staff to cope with workload.”
This situation can apply to businesses that need fast capital injections that they know they can repay reasonably quickly, i.e. gearing up for the busy season.
Some experts recommend following the rule ‘don’t finance long-term needs with short-term money’. For example, a short-term loan would be better suited for buying inventory or making a vital repair instead of financing significant equipment purchases.
“Kit or equipment might be better financed over its life cycle, rather than through a short-term loan,” Philip recommends.
3) What are the the pros and cons?
Knowledge is key in reaching the best decision for your business. When comparing long-term and short-term loans, consider factors like these:
The price of the loan: While short-term loans tend to be available more quickly and easily, their interest rates are also generally higher than that of long-term loans
How soon do you need funding: Long-term finance will take considerably longer for assessment and approval
Are you willing to put down collateral: Short-term funding is more likely to be unsecured, with no need for a personal or director’s guarantee
Carefully consider your options and work out what the opportunity cost of not accessing finance straight away would be. For example, a supplier has offered you discounted inventory, but you don’t have the working capital on hand to immediately respond. Calculate the amount of revenue you would lose if you didn’t take this opportunity. If the loss is greater than the total cost of the short-term loan, including interest payments and set-up fees, it could make commercial sense to apply for a loan.
While business financing isn’t an exact science, following some core principles will help you take the most strategic approach. Both short and long-term loans can help your business grow, and investing time in research will give you the best results. As Philip says: “Finance your needs in the right way with the right advice.”
This article was written by Stephen Whelan, Business Relationship Manager at Spotcap UK.