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An Introduction to Short-Term Financing for Small Businesses

  • January 26, 2022
  • 468 views
  • 5 minute read
  • Rene
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Small businesses are the backbone of the American economy. But even the most successful local establishments can run into trouble when they need to finance a short-term expense. That’s where short-term financing comes in – it provides the cash flow a business needs to cover unexpected costs or make a necessary purchase.

Short-term financing is available in various forms, including loans, lines of credit, and factoring. Each type has its benefits and drawbacks, so it’s essential to understand your options before deciding which one is right for your business.

Short-Term Financing Options

There are several options for short-term financing, so it’s wise to develop an understanding of each before selecting one for your business.

Business Cash Advance Loans

Business cash advance loans are short-term financing that allows a business to borrow a large sum of money. The loan is secured using the business’ cash flow as collateral.

The borrower must pay back the money within a specified time frame as short as thirty days or as long as one year. To repay it, you usually have to regularly withdraw a set amount of money from your business bank account. The frequency of withdrawals depends on the lender and how much you borrow.

Business Lines of Credit

Don’t take out personal loans if your business frequently needs money for short-term expenses. Instead, a business line of credit might be a good option. For example, companies typically use lines of credit to pay their suppliers and employees when they make short-term purchases.

A line of credit is essentially a bucket with an open-ended borrowing limit. It works like this: you take out the money you need whenever you want it and then repay it once your bill comes due (usually in thirty days or less). You can borrow and repay for as long as your line of credit remains open. There’s generally no set time frame for repayment.

Peer-To-Peer Loans

With peer-to-peer (P2P) lending, you borrow money directly from individual lenders. After you submit your application, P2P websites match you with potential lenders. You choose which ones to work with based on their requirements and interest rates.

The funds must be paid back over a fixed term, often between one to five years. There’s no collateral involved because investors share the risk among them instead of the risk falling entirely on the business owner. That helps keep interest rates low compared to traditional credit or other forms of short-term financing.

Factoring

One of the primary uses for short-term financing is to cover the costs of bringing goods to market. Factoring is a type of short-term financing that provides cash in advance for your future sales. You sell your accounts receivable (i.e., invoices) to raise capital with factoring.

The factor, not your customer, actually pays you for the invoice first, allowing you to keep making sales before chasing customers down for payment.

Credit Card Cash Advances

Credit card cash advances can get you quick financing, but they also come with high-interest rates and several other fees. On top of that, credit card terms are relatively short – typically just thirty days from the purchase date to repay the advance. These short terms force you to pay back in full before your due date to avoid late fees.

If you can find short-term business financing outside of credit card cash advances, you and your business will be much better off. Credit card cash advances should always be the last resort for any business and its financing.

In addition to the financing options above, some short-term loans are available to small business owners.

Types of Short-Term Loans

There are two main types of loan agreements: secured or unsecured loans.

Secured Loans

These types of loans require you to use value as collateral for the loan. It could be a car, equipment, or another valuable asset. Secured loans are most common for businesses that need to borrow a large sum of money.

Unsecured Loans

With unsecured loans, you don’t put up any collateral. Instead, the lender relies on your creditworthiness for repayment (i.e., your ability to repay the loan).

These loans typically offer lower interest rates and more flexible repayment terms than secured loans. As a result, unsecured loans are most common among businesses that need a small amount of financing (between $500-$25,000) for short periods (less than six months).

The critical difference between both is the security (or lack thereof) to protect lenders against default risk where unsecured loans provide none. In contrast, secured loans offer some property to guarantee repayment if required.

However, there may be different requirements, such as specific credit scores or qualifications needed before approval, restricting interested parties from applying irrespective of whether it is an unsecured or secured loan.

Types of Lenders

Depending on the lender and how much money you need, you might find that different lenders offer better rates and terms than others. If you want help finding the right source for your short-term financing needs, check out this list:

Commercial Banks

These aren’t as common as they once were, but they still make short-term loans. Since banks don’t give out a lot of short-term financing, they often have more stringent requirements for applicants.

Factoring Companies

Sell invoices to finance companies that buy the right to collect on those invoices. The size and frequency of your transactions can determine how much money you can borrow from a factor.

Smaller Lenders

Some websites specialize in connecting business owners with small amounts of capital – anything less than $25,000 – under a variety of lending models, including lines of credit or asset-based financing.

When Should I Apply for Short-Term Financing?

It’s never too soon or too late to start exploring the different finance options available to small businesses. If you need cash quickly, applying sooner rather than later can help ensure your application’s approval by providing more time to secure the funds.

On the other hand, if you’re not in a hurry and would rather wait until your business is more substantial before you seek financing, applying too soon can prevent that.

Remember that loan eligibility depends on your situation. There’s no point in requesting $50,000 if you can only borrow $5,000. Insufficient qualification could even mean that the lender declines your application immediately.

Parting Shot

Short-term financing is a great way to ease cash flow issues that frequently come up for small businesses. All it takes is the right timing, the correct type of loan, and the right lender. If you can meet those criteria, then small business short-term loans are an option worth exploring and can help you advance your business how you want.

____________________________________________________

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