Sooner or later most businesses run into a shortage of working capital - the cash a business has on hand to cover its payments to staff and suppliers or to make purchases of essential assets. Rather than defaulting on obligations and facing potential bankruptcy, or delaying essential purchases and missing out on a profit opportunity, one sensible solution to a cashflow shortage may be to obtain finance in the form of a short-term business loan.
What is a short-term business loan?
As the name implies a short-term loan is a rapid injection of working capital that is repaid over a period of one to twenty-four months. Short-term loans are available from a variety of different lenders from high street banks to alternative providers which specialise in short-term finance. Short-term business loans are often available at much shorter notice than equivalent medium-long term loans with a trade-off coming in the form of higher interest rates.
Benefits of short-term loans
Short-term loans carry numerous benefits compared to medium-long term loans when used in the right circumstances.
Firstly, and most obviously, the loan is repaid faster. The business isn’t saddled with repayments and interest charges which extend far into the future, potentially reducing its profitability and possibly affecting its ability to secure further financing.
Short-term business loans can often be much quicker and easier to obtain than medium-long term equivalents. This is especially true when using one of the new alternative providers which operate exclusively through an online platform. Getting the funds into the business’s bank account quickly can be invaluable when a cashflow shortage or purchasing opportunity has arisen unexpectedly.
Many short-term business loans offer a degree of flexibility. Some allow you to draw down, and pay interest on, only part of an extended line of credit (a ‘revolving credit facility’), while others allow you to make repayments as a percentage of future revenue (a ‘revenue advance facility’).
Potential risks of short-term loans
When used for the wrong reasons short-term loans can be detrimental to a company’s financial health.
Monthly repayments can be much higher with short-term loans than with medium-long term equivalents. This results in a bigger drain on short-term cashflow.
Short-term loans often carry higher interest rates than equivalent medium-long term loans. These higher rates can eat into the short-term profitability of the business.
The easy availability of short-term loans can encourage poorly thought-out borrowing decisions which can lead to an ever increasing debt burden and potential bankruptcy.
Flexible short-term finance can result in unpredictable interest payments which increase the difficulty of short-term financial forecasting.
Alternatives to short-term business loans
There are several alternative options to explore before settling on a short-term loan facility.
A business overdraft facility will probably be available from your current business banking provider. An overdraft is a flexible credit facility where you only pay interest on the part of the overdraft that you use, usually at a similar, or cheaper rate, than a short-term loan. Banks, however, normally charge an arrangement fee which needs to be taken into account to work out the overall cost.
Business credit cards are also often available relatively easily from your bank. As well as extending a line of credit for purchases, they can come with the additional benefit of interest free periods which last up to two months. They can also make small purchases easier and easier to track. They often come with hefty interest rates when compared with loans, however, and there are often fees attached.
Invoice finance, where you borrow against your unpaid invoices, is offered by some banks and specialist finance providers. You can often release up to 95% of the cash tied up in unpaid receivables with the remainder of the cash released when the customer makes payment. This kind of finance, however, comes with both interest and fees attached and you can’t borrow more than you’re owed.
When should you consider a short-term business loan?
As noted above a short-term business loan often comes with higher interest rates attached than an equivalent loan repaid over a longer time frame. You should therefore only consider a short-term loan when circumstances demand it e.g.
- you need to quickly make an investment that will generate a greater profit than the overall cost of the loan;
- you need to plug an unexpected gap in your cashflow in order to avoid defaulting on your obligations;
- you don’t want to affect your ability to borrow over a longer time frame at a later date;
- your poor credit rating disqualifies you from cheaper forms of borrowing.
You should never take out a short-term business loan to finance ongoing losses.
Where to go for a short-term business loan
The following are all sources of short-term loans:
Most banks offer fixed rate loans over as short a period as 12 months. These are often the lowest interest rate loans available, but also the most difficult to obtain in terms of lending criteria. Unless you have a good ongoing relationship with your business bankers it’s unlikely that you’ll be able to obtain a short-term loan quickly.
Peer to peer lenders
Peer to peer lenders connect savers with borrowers without the need for banks. They can offer fixed rate business loans of up to £1 million over as short a period as 6 months. While loans are often easier to obtain from P2P lenders than from banks, and have comparable interest rates, they also often come with fees attached.
Alternative finance providers
Specialist short-term lenders provide one of the easiest and potentially fastest routes to short term loans of up to £120,000 or a multiple of your monthly revenue. There is also a large choice of how you draw down the loan facility and how you repay. But, interest on such loans is often charged monthly, which means annual interest rates are often very high when compared with loans from banks or peer to peer lenders.