What is the real difference between short-term finance vs. long-term finance? As a small business owner, you have likely come across these terms and other financing products that can help you grow and develop your business.
Exploring these funding opportunities can benefit your business with time, which is why we have created the ultimate guide for short-term finance. We will explain this type of financing, its characteristics, advantages, disadvantages, and examples, so you can genuinely consider if this is the right choice for you. Let's begin by defining it!
What is short-term financing?
Short-term financing is the type of financing where your business uses short-term sources, meaning the length of the payback period lasts less than one year. Short-term financing is typically used for a single purchase or a single sum of money. As a borrower, you are unlikely to use the same short-term financing source more than once or twice.
Characteristics of short-term financing
You can use them when you are not eligible for credit lines or traditional business loans from banks: These are precious options for small business owners because you can acquire smaller amounts – between $5,000 to $500,000, sometimes even more. Since you might not be eligible for a bank loan yet, short-term financing options can let you acquire fast working capital when you require cash flow to reinvest in the business. For more information about the types of short-term financing?
You can pay them off quickly: As their name suggests, you can pay these off quickly. In most scenarios, you need to pay between 6 and 18 months.
You pay at your own pace of your business: Most financing options of these sorts don't have a specific payment schedule or due dates per se; the repayments are a percentage of either your invoices, your credit card transactions, or bank balances. You can essentially pay back the financing at your own pace.
Example of short-term financing
Let's say you own a small coffee shop. You need to take a loan to grow your operations during high season since there are many more people walking around, thanks to the great weather. After making numbers, you land at $10,000 for six months, so you can get a new espresso machine and hire two more baristas. Because this loan is for six months, it is short-term financing. You will need to repay the amount and the interest during or after those six months. It is likely that you will be in a stronger financial position and will be able to quickly repay this small loan.
Advantages of short-term financing
Sometimes, you can have the funds in your account in less than a day! Fast capital can be useful during emergencies when you need working capital fast or during the low months or seasons of your business.
Easier Processes: How can you get the fund these fast? Well, because the process of applying and getting them is more straightforward. Short-term loans are less risky, so the documents required are fewer, making them very approachable. Additionally, since these are not traditional loans, like MCA's, the capital cost can be considered tax-deductible, unlike conventional business loans.
Ability to Renew: Once you start a relationship with a short-term funder, and you show that you are a growing business, pay on time, and other characteristics that are attractive to them, you can essentially look at that funder as your capital arm in your company. Because now you've gained their trust, and the process to get funded again becomes more accessible and faster, and if the business grows, you will probably get higher amounts for better terms.
Disadvantages of short-term financing
You May Affect Your Credit Score: One of the downsides of short-term financing is that if you can't pay back the loan within the year period, it can adversely affect your credit score. This can lead to you needing more loans to pay off others, leaving you in an endless cycle of borrowing. For this reason, you need to read your market and project numbers thoroughly before getting any type of finance to ensure you can pay off what you owe while growing your business.
Can Be More Expensive: Short-term finance solutions can become costly because you will have to pay higher rates since you have less time to pay. For this reason, it can be more challenging to pay what you have borrowed on time.
More Frequent Payment Installments: With the payments being established for a year only, they are also more frequent - sometimes weekly or daily. You'll have to pay in larger chunks and more installments with shorter payment terms than with longer-term options.
Are short-term finance options for you?
Now that we have a better understanding of short-term finance options, you might be wondering if it's the right choice for you and your business. Ultimately, there are many benefits to either long-term or short-term finance, depending on your specific needs.
Considering what we covered, short-term financing is more accessible and easier to qualify for, and there are various types for you to choose from. They are beneficial for sudden cash flow problems, emergency funds, and low seasons - especially for small businesses that are just starting and need cash but are considered riskier borrowers. Nonetheless, it is always important to be aware of the consequences of nonpayment and how it can affect your company and its credit score.
If you find that you need working capital quickly and that short-term finance is the right option, we can help! As long as you have at least three months in business and at least $7,500 in monthly revenue, we can help you find the working capital you need fast, and you can be funded in as little as three business days.
Disclaimer: The content of this article is based on the author's opinions and recommendations alone. This material has been prepared for informational purposes only. It is not intended to provide and should not be relied on for tax, legal, or accounting advice. We suggest consulting with your tax, legal, and accounting advisor before engaging in any transaction.