All businesses go through times of uncertainty. In fact, every year, one in six small and medium enterprises (SMEs) seek finance to fund and grow their business.
Whether you’re experiencing growing pains, lean times or cash flow gaps, business finance can help your business run more smoothly. Two popular options you might consider are a business loan or a line of credit.
Both financing options have unique advantages and disadvantages. Choosing which loan is best for your business will depend on your specific needs and circumstances.
What is a business loan?
A business loan is a lump sum of money that a business borrows from a lender, which is then repaid over a fixed period with interest. Business loans typically have a set interest rate and repayment schedule, making it easier for you to plan and budget your expenses.
Loans can be secured or unsecured, meaning that the loan may or may not require collateral to secure the loan.
How do business loans work?
Once you’ve been approved for a loan, the bank or lender transfers the funds as a lump sum to your business bank account. It’s important to know that interest will begin to accumulate on the loan immediately. You’ll have to pay back the loan, with interest, monthly.
Benefits of a business loan
One of the primary benefits of a business loan is that it provides businesses with a fixed amount of money upfront, which can be used to cover a specific expense or investment.
Business loans also typically have lower interest rates than lines of credit, making them a more cost-effective financing option for larger purchases or investments.
Business loans have the added advantage of helping you build credit history. This can make it easier to secure further financing in the future.
What are business loans best used for?
Business loans are better for larger one-off expenses such as:
- Expanding your business
- Purchasing a new building
- Buying or updating equipment
- Investing in marketing campaigns
What are the downsides of a business loan?
The process of applying for a business loan can be time-consuming and require significant documentation, especially if you apply through a traditional bank. Banks may want a copy of your financial statements, your business plan, and copies of your tax returns.
Another downside is that if your loan is secured, the collateral could be at risk if your business is unable to make repayments.
What is a Line of Credit?
A line of credit is a flexible form of financing that allows businesses to access funds as needed, up to a certain limit. Unlike a business loan, a line of credit doesn’t require you to borrow a lump sum of money all at once.
Instead, businesses can draw from their line of credit as needed, up to their approved credit limit. Interest is only charged on the amount of money that is borrowed — not the whole line of credit. This makes a line of credit a cost-effective financing option for businesses that have fluctuating cash flow.
How does a line of credit work?
Like a business loan, a business owner can apply for a line of credit with a traditional bank or non-bank lender. The process is usually less rigorous than applying for a business loan.
Once approved, you can draw down on the line of credit as often as you like for as long as the draw period is for. You’ll only pay interest on the money you use. Interest repayments on a line of credit are usually higher than for a business loan.
Benefits of a Line of Credit
One of the primary benefits of a line of credit is that it is a flexible lending option. Your business can draw from your line of credit whenever you need to. This makes it great for managing fluctuating cash flows or paying for unpredictable expenses.
When you apply for a business loan, most lenders want to know exactly what the loan will be used for and exactly how much money you need. With a line of credit, you won’t need to disclose the use case when you apply.
Lines of credit typically have lower interest rates than credit cards or other short-term financing options. This makes them a more cost-effective option for short-term borrowing.
What is a line of credit best used for?
A line of credit is better for flexible cash flow support, such as:
- Paying suppliers or wages
- Buying stock
- Covering unpaid invoices
- Bridging the gap between invoice and payments
What are the downsides of a line of credit?
Lines of credit can be more expensive than business loans, particularly if your credit limit is high and you carry the balance for a long time.
Interest rates on lines of credit are often variable, which can make it difficult to plan for future expenses.
Which is better: A business loan or a line of credit?
The decision on whether to take out a business loan or apply for a line of credit depends on several factors, including what you’ll use the funds for, how much you need to borrow and your business’s financial situation.
In general, business loans are better for long-term investments, such as real estate or large purchases, while lines of credit are better for short-term expenses or managing cash flow.
It’s important to consider the interest rates, repayment terms, and any fees associated with each option. Working with a financial expert is a great way to determine which loan is right for your business.
Whatever your commercial lending needs are, ThinkCap can help you secure funding that works best for your business. Contact us today or apply now for a business loan or line of credit.
