Businesses take loans for various reasons and they come from various sources, each with its own stipulations and pros and cons. Short-term business loans, for example, provide business owners with a flow of fast cash in order to handle emergencies, bridge cash-flow gaps, to fund a new project, explore a business opportunity, and so on. They are basically quick-turnaround loans, which must be fully repaid soon, usually within a few years.
But before discussing any further, let’s take a look at what a short-term business loan is.
Short-term business loans, as the name suggests, are basically term loans with a characteristically short repayment term. Ideally, with such a loan you need to pay back the loan amount along with the interest within three to 18 months. Sometimes, you need to make daily or weekly payments. And this is where it differs from long-term business loans, which includes monthly payments over a number of years.
Since this kind of loan has a shorter repayment period, their interest rates are also higher. Moreover, the loan amounts are smaller than those of long-term loans and they are typically secured through alternative lenders.
How Good are Short-Term Loans?
Any loan is a financial risk and poses a threat to your assets, especially if you are unable to repay them on time. And short-term loans are no exceptions. There are many horror stories where small business owners take out short-term loans online to fulfil their fast cash needs, only to get stuck in an endless cycle of crushing debt and greedy lenders. Such incidents happen way too often, especially when people agree to loan terms without considering its effect on their credit report and business’s cash flows.
That being said, short-term loans will not necessarily bankrupt you. In fact, there are many perks involved. For example, the cost of capital for short-term loans is generally much lower as they accumulate interest for a shorter period of time. Besides, they are much easier to qualify for when compared with long-term loans. But it is important to be cautious and diligent and know when to opt for a short-term loan and when to give it a pass.
When to Consider a Short-Term Loan
The first question you need to ask yourself is: What is the purpose of the loan? Based on this you can determine the amount of capital you need to borrow and on what terms. If your loan purpose is to overcome a temporary cash-flow problem, a short-term loan can be a tremendous help. The following are 5 situations where a short-term business loan would be useful:
1. To Cover Start-Up Costs
Since short-term loans are relatively easier to qualify for, they can be granted to both existing and new business owners. This means you can leverage such a lending mechanism also to finance your start-up costs. Moreover, the approval usually happens quickly, sometimes even within a day; and since you are making daily or weekly payments, the lender can overlook your credit report, even if you have a weak one.
2. To Purchase Inventory
Short-term loans are particularly helpful for retail businesses. For example, if you need to purchase inventory for the holiday season well in advance but lack the cash, such a loan term will help you meet the requirement. The good news: You can repay the loan until after the holidays. Similarly, you can leverage such loans to purchase quick-turnaround inventory at a discounted rate in order to make some additional profits.
3. Emergency Situations
A short-term loan is a good option to make it through an emergency situation, whatever it is. However, you must be 100% sure about how you’re going to repay that loan and not leave to chances. Most of the short-term business loan horror stories occur when owners end up borrowing the money without having a concrete repayment plan.
4. To Start-Up a Project
Sometimes new projects come with upfront costs, which are often unexpected. If you don’t have enough cash flow to cover the cost at the moment but will be able to repay within a couple of months, it makes sense to go for a short-term loan. Likewise, they are helpful to cover your short-term operational costs such as hiring more employees (on a temporary basis) during a seasonal push to make more sales.
5. Cash Flow
As said earlier, short-term loans are ideal for temporary cash flow situations, thanks to their shorter-than-usual maturation periods. If you can cope with the pressure of daily loan payments and are sure to have your money coming in within a short period of time, it is a good decision to opt for such debt schedules. However, if daily loan payments are a challenging option for your business model, it is better to give a short-term loan a pass and consider looking elsewhere. In fact, it is really not a good idea for businesses that have a lot of daily expenses, gain revenue infrequently, or have just a few clients.
Loan Purpose Matters
Understanding your loan purpose is the key factor when considering the terms of a loan. In dollar cost-sensitive situations like purchasing new equipment or inventories where the businesses are likely to make a better return for every dollar they borrowed, a short-term business loan is particularly helpful. However, there are still factors you need to consider, such as:
Who is lending the money?
It is better to opt for a lender who specializes in the type of loan you need.
How much capital do you need to borrow?
Make sure it is not a penny more than what you require as the interest rates are considerably higher.
What are the loan terms?
This includes not only the interest rates but also the period of the loan as well as the repayment option. Make sure it makes the most sense to your business model. Remember that early payments are a complicated topic here.
Getting stuck in a vicious cycle of endless short-term loans can often lead to business bankruptcies, especially if you are clueless about when to consider such a debt schedule. One tip here is to never use short-term loans to repay other short-term loans. The stakes are too high here: You have to pay a higher interest rate for the new loan and your old interest(s) won’t be forgiven either, meaning – you will only have to pay more.
Instead, use it as a tool to pursue new revenue-generating opportunities where your return on investment is higher than that of those interest payments.
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