Short-Term Business Loans – Pros & Cons

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source: project2040

Irrespective of the field of activity, all businesses require funds to operate, expand and diversify. The requirement may be for working capital to streamline cash flow in times of cash crunch, for capital investments in expansion and diversification, or upgrade and replacement of machinery and equipment, among others. The nature of requirement varies, basically determining whether the fund need can be met with long- or short-term credit. All the lenders in the market cater to the needs of the business, but it is upon you to decide whether you need a short-term loan or a long term one. The decision is critical to the health of the enterprise, as a business loan is primarily meant to bridge gaps in fund management. While every credit facility comes with its pros and cons, it is sensible to first gain insight into the nuances of short-term loan to ensure that you are on firm ground to assess the pluses and minuses before you commit.

The basics of short-term business loan:

The very name is suggestive that the life of this business loan is short. These are sometimes referred to as bridge loans, and it is primarily meant to tide over the temporary monetary crisis. The loan is eminently suited for Start-up and SME business enterprises which find it difficult to source funds in a conventional way. A short-term business loan can be used for meeting the needs of working capital, expansion, hiring of fresh employees, or running a promotion campaign being a few common examples.

Every lender has products to match such a need, but the online lenders have made the process least cumbersome and collateral-free to boot. The loan can be in the form of installment repayment mode or line of credit – a rolling facility. Thus, it offers a viable option to small businesses to approach them in times of need.

Are there different types of short-term loans?

It goes without saying that every credit product may have its variants to match singular preference. So is in the case of a short-term business loan. Let us check out the different forms of short-term business loan in the market.

Trade Credit: It is one of the most affordable credit facilities around. It works on the principle of a moratorium when a lender may offer you a short holiday to repay the advance, typically up to 30 days. It works in the case of paying for a purchase from a seller. It is interest-free during the grace period, and any tenor over the agreed-upon terms may attract imposition of interest.

Bridge Loan: These are typically meant to tide over the period where you are looking for a higher funding deal. This loan takes care of the interim period when you may be short of money till the final loan comes through. It is thus a loan that fills the temporary cash gap.

Demand Loans: These loans are provided by the lenders for a definite period, which in the case of the short-term loan is for a maximum 24 months. The name demand is so defined to establish the right of the lender to call the loan.

Overdraft: It is also called the line of credit, as it denotes a rolling credit facility. Your current account can be converted into an overdraft account with a mutually agreed upon borrowing limit, allowing you to withdraw up to the limit at will. You can repay at will too, and the interest is charged only on the amount used and not on the limit.

Is a short-term business loan the right credit product?

The most important feature in running a small business is ineffectively allocating available funds. Sound financial planning and practices can rationalize your operational cost and help achieve potential growth. Every business is possessed with a different character, as much as the owner, and thus, there is no one solution to fit all. So, it is incumbent upon you to gauge your necessity in the perspective of what is best for your company.

Before committing on any product, it is best to weigh all the options. If the purpose is served by alternative long-term credit, then a short-term loan becomes a burden. The risk is always inherent. If your business has relatively quick cash flow cycles and other reliable sources to liquidate the debt. When your business is strongly benefited by immediate infusion of funds, it is perhaps the only choice. It is entirely dependent on the specific conditions and the nature of the need for the business. A snapshot of a short-term loan should be enlightening.

Pros of short-term business loans:

Fast Processing: There is no denying that short-term loan experiences least hassles and online lenders sometimes disburse such loans within 24 hours. When the business needs immediate funds, this the best bet as it calls for relaxed eligibility and bare essential documentation.

Simplified Application: The application process, especially with online lenders, is extremely simple and entirely on a digital platform. It, therefore, results in faster processing and disbursal of loan.

Liberal Eligibility: For the approval of such loans, poor credit history is not necessarily a constraint. When a short-term loan is considered, the credit score, both personal and business, are not stringently applied.

Cons of short-term business loans:

The risk of debt trap: Any credit facility is fraught with the risk of default, more so in the case of the short-term loan, where you need greater revenue resource to service the loan with relatively higher EMI. Your confidence and the resilience of the business should be factored in, where you have a definite roadmap for repayment of the loan. Else you can end up jeopardizing the future of your business.

Repeated Repayment: Each short-term loan requires frequent servicing, including repayment. In some cases, it is daily putting a strain on the cash flow. If you do not have a consistent source of fund replenishment, the short-term loan does not work for you.

Higher Interest: Short term loans always charge a much higher rate of interest by every type of lender. The lenience in fast processing is offset by the higher rate as compared to a loan with longer terms. So, for faster receipt of funds, you pay with a greater capital cost. You can save up on the higher cost by repaying the loan in a quick time.

Bottom Line:

There are no two opinions about the fact that all credit products, whether a short-term loan or a longer variety, carry a certain amount of risk with different sets of pros and cons. Yet, there may be times when a short-term business loan works as a savior to help your business survive. Thus, a loan needs prudent use to make the best out of it to help the business achieve its potential to the fullest.

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