There are various ways you can finance a business depending on your particular needs. Some companies may be in need of additional capital to fund day-to-day operations, while others may need the money to make a big purchase.
Whatever the case may be, there are different options that are geared towards specific situations and certain types of businesses. Lending money, in whatever form, involves at least some level of risk, so it’s essential that regardless of the method you choose, you know exactly what you’re doing and what you’re in for.
In the most basic sense, a business loan is a lump sum of money that is borrowed for the purpose of purchasing a fixed asset, while a business line of credit is capital that’s borrowed from an institution that can be used for general, everyday purposes.
Both methods of financing involve both advantages and disadvantages, depending on the specific situation.
What Are Business Loans?
A business loan is normally a fairly large sum of money, a lump sum, that is borrowed from a financial institution or another accredited lender. The loan is paid back over a specific period of time at a specified interest rate.
The terms of the loan, including the repayment period and interest rate, are determined when the loan is taken out and they’re normally confirmed by means of a signed, legally binding contract.
Business loans are intended to be used for purchasing:
- Inventory
- Assets
- Property
- Franchises
Alternatively, business owners also take out loans to fund things like:
- Loan Repayments
- Business Startups
- Mergers and Acquisitions
- Expansion
…and more. Ultimately, the purpose behind business loans is to fund purchases or business activities that are planned and expected to cost a fairly large amount of money. The company in question normally needs to provide the financial institution from which the loan is coming with proof of the intended purpose of the money, along with plans on how the business intends to afford repayments.
Pros of Taking Out a Business Loan
- The funds are normally paid out in a single lump sum.
- Often, tax deductions are available on business loan amounts.
- Interest rates are normally quite reasonable.
- Large amounts of money are available for loans compared to other business financing options.
- Can help improve your business credit.
- Terms of business loans tend to be quite flexible.
Cons of Taking Out Business Loans
- Eligibility requirements are very strict.
- Incurs risk and financial strain on your business.
- Some business loans can only be used for specific purposes.
- May require collateral.
Weighing up these pros and cons will come down to what your business’s needs are as well as your current situation. For instance, taking out and successfully repaying a business loan can be a great way to increase your credit score, on the one hand. But on the other hand, if you need the money to finance a business acquisition and the financial institution you’re working with doesn’t allow that, it’s not going to be ideal for you.
At the end of the day, it all comes down to the specific company, the desired loan amount and the financial institution in question.
What is a Business Line of Credit?
A business line of credit, on the other hand, is also a loan of sorts, but it functions differently from a straightforward business loan.
Essentially, it’s a super flexible loan that functions similarly to a credit card. Business owners can borrow as much as they need at any given moment (up to their credit limit, of course), and then pay it back over time.
This is a great option for companies who may be just starting out or struggling with cash flow. It helps create a kind of safety net and financial buffer.
In many ways, a business line of credit can be a great alternative to a full-on business loan because it’s not as rigid and it can be smaller amounts of money.
Pros of Using Business Credit
- Improve cashflow and better cashflow management.
- Helps businesses build a positive credit score.
- Allows for flexibility in that money can be accessed whenever.
- Fast access to funds.
- No collateral is required.
Cons of Using Credit
- Interest rates can be high.
- Can be risky.
- Often offer low limits.
- May be tempting to overspend.
- Often come with additional fees.
Business lines of credit offer a pretty quick and easy way to access money without having to submit complicated applications and wait ages for approval.
However, this flexibility comes at a cost, in that interest may be higher than on a business loan and businesses don’t tend to have access to as much money.
Business Loan Vs. Business Credit: A Direct Comparison
The decision between a business loan and a business line of credit really isn’t something that can be prescribed. Rather, individual businesses, financial institutions, financial standings and more need to be considered.
So, based on the varied offerings of business loans as opposed to business lines of credit, the main questions you need to ask yourself are:
- How much money do you need to borrow?
- How quickly can you pay it back?
- How much interest you can afford to pay
- How urgently do you need the money for?
- What do you need the money for?
- What does your credit score look like?
- How much risk can you afford to take?
- Can you provide collateral?
Answering these questions may not give you the answer you need immediately, but it will give you a better idea of what you’re looking for and which option will best suit your needs.
