The two most common forms of credit for small business are a small business loan and a line of credit – do you know the difference?
Small business owners throughout Australia are used to growing their business with their profits generated by the company, but in 2021 and 2022, this may not be enough.
In many cases, they will need a helping hand to get them through tough times or business downturns.
Getting outside funding for your business can be the kick you need for survival, and without this, you may end up having to close your doors. Not ideal and not the way you intended your business to go. But helping you with your cash flow could be the lifeboat you need to survive in these very uncertain times.
The variety of financing options are enough to turn many people off. It might be the amount of paperwork, dealing with banks, or perhaps just not knowing the difference between the different loans. It’s enough to make anyone’s head spin with information overload.
Going to the local bank is not the only option for a business loan as there are now many new lenders helping business with their loans, like Sparrow Loans, who can hold many small business owners hand and guide them through the lending process maze.
Lenders like us at Sparrow Loans can get funding to businesses much faster than banks and respond to clients needs as they are more nimble and agile, especially during this COVID period.
For most businesses, they will need either a
-line of credit
The experts at Sparrow Loans explains the difference between the two business loans.
Business loans sometimes called term loans, provide business owners with a lump sum to pay back over an agreed period with interest. It’s your standard and most common loan that businesses will apply for. But, this is where it can get tricky as there are a few types of loans for different purposes.
1) Long-term business loans are designed to finance long-term investments or projects, such as purchasing or office/building fit-out. These loans are for more extended periods and are similar to taking out a home loan if you need a comparison. The payback period is three years or longer – so you are on this loan for the long haul.
2) Short-term business loans, AKA working capital loans, help businesses get over immediate cash flow shortages and financial hurdles. These include buying inventory, paying staff, rent, new equipment for the office or warehouse or any other expenses that need immediate attention.
Short-term loans will typically have a six-month to 12-month term.
Banks, financing companies, or lenders like us at Sparrow Loans are offered loans that can help your business out of sticky situations.
How Do You Get A Business Loan?
You can get business loans from banks or lenders. Bank loans typically have the most stringent paperwork, which may include a thorough outline of your business plan, previous bank statements, trading history, credit checks and proof of the ability to pay back the loan. Plus, you might have to provide security for the loan in the form of bricks and mortar collateral such as your home. If you are lending money for capital equipment, you will have to use that piece of machinery as collateral.
Business loans typically have fixed interest rates over the life of the loan. The interest rate will vary depending on the loan amount, the type of loan, the lender and your business’s creditworthiness.
What Is a Business Line of Credit?
Think of it as a credit card. A business line of credit allows you to borrow up to a set limit. You can pay off the total amount whenever you like or pay off a minimum amount each month, depending on your business cash flow. If you run into any cash flow issues, all you need to do is borrow from your account line. It gives you the safety and security that there’s some money there in case of an emergency. Plus, you don’t have to reapply each time you take the money. It’s there for you anytime you need it.
Line of credit is short term only, and smaller amounts and are incredible for:
- i) retailers that might need extra cash to buy inventory for an upcoming sale.
- ii) manufacturers that want to buy a small piece of equipment.
iii) businesses that have some bad creditors and need to pay for the day-to-day running of the business while they chase these outstanding invoices.
Generally, if you need $250,000 or less, a line of credit is the perfect option. It’s simple, requires less paperwork and can be in your account much sooner.
How Are Business Loans and Lines of Credit Different?
Business loans and lines of credit can provide the capital with your business needs for growth or help you in uncertain times with extra money. But, there are some crucial differences between them.
As stated above, a business line of credit is similar to a credit card. The money is there if you need it, and the interest will only begin accruing once you draw on the funds. And, if you don’t use the funds, you won’t pay any interest. Think of it as a safety net. The money is there for a rainy day.
A business loan is instalment credit. You receive a lump sum and make fixed monthly payments on it every month. You begin paying from the moment you get the money.
A business loan must be used for a specific purpose that you will detail in your loan application. You cannot use it for any random purpose, such as paying staff or purchasing inventory, where a credit line is valuable. This is where a line of credit is so helpful gives you the flexibility to pick and choose where you spend your money. Remember, the larger the amount of money borrowed, the stricter the lending criteria.
Which Type of Financing Is Best for Your Business?
Are you wondering what the best type of loan for your business is? And, are you still confused about a line of credit or business loan? The following categories will point you in the right direction.
How much money do you need?
If you need less than $250,000, go for the line of credit. Anything over this amount will generally require a business loan.
What will you use the money for?
Buying a building, office, warehouse, or perhaps doing an office fit-out or renovation that requires lots of money, then a business loan is applicable. For access to fast cash for small projects or to help with cash flow issues with no restrictions, then a line of credit is the way to go.
Do you want flexibility or predictability?
If you’re the type of person that needs predictability in your business with set monthly repayment amounts that you can budget for, then a business loan is perfect. You have fixed monthly payments, and you can plan for the loan g term incorporating these fixed outgoings. If you like flexibility and knowing you can repay the loan faster, then a line of credit is more suitable. But, bear in mind that interest rates are variable and can fluctuate with lines of credit depending on market conditions. If you’re comfortable with this and your sure you can repay the monthly interest, this is perfect.
How good are your business and personal credit scores?
Your creditworthiness will affect the amount of money you can borrow and the terms for which you’ll qualify. Lower credit scores may make it harder to borrow more significant amounts. If you have had a bad credit history but you’re confident about your business venture, try the line of credit for a smaller amount of money and build your credit score up. Once you can demonstrate that you can repay your loan on time without any hiccups, you can try and apply for a business loan to take your business to the next level. You can go to the Money Smart website published by the Australian Government to check your credit score.
Can a small business loan and line of credit be combined?
Yes, you can, and many Australian businesses will have a strategy of combining a business loan and line of credit. Businesses have highs and lows, and having access to funds gives you peace of mind. Some companies want to say buy a large piece of machinery while having a line of credit to pay the big superannuation bill or ATO tax debt coming up.
If you are looking for a property-backed business loan, or do you have a loan with us and need an additional line of credit? Talk to Sparrow Loans today.