When does a short-term business loan make sense?

23rd February, 2016

Today, more than ever before, there are many financing options available to small business owners. 

Depending on the business reasons for seeking a loan, some loan options may be a better fit than others. Having a clear understanding of the purpose of the loan should be a major driver for most loan decisions, and will help any small business owner determine the type of financing that makes the most sense to meet his or her business needs.

For example, financing the purchase of a new warehouse or piece of heavy equipment will likely require different terms than purchasing inventory or bridging a short-term cash flow gap.

In the same way nobody would finance the purchase of a car with a 30-year term loan – regardless of how ridiculously low the periodic payments might be – some business purposes are better suited to short-term financing. Just as the total interest paid on a 30-year car loan doesn’t make sense when purchasing a new car, it probably doesn’t make sense to use long-term financing to meet short-term needs for capital.

Good reasons for using a short-term business loan

Although a four-, five-, or 10-year term loan can makes sense for many loan purposes, here are four examples of business financing needs that could be better suited to a short-term loan:

  1. Purchasing inventory at a discount: It’s not uncommon for a small business owner to require quick access to short-term financing to take advantage of a business opportunity. Purchasing specially priced inventory that will turn quickly and provide additional profits can be a good reason to use a short-term business loan.
  2. Overcoming a seasonal cash flow gap: Many seasonal businesses sometimes require an additional influx of capital to meet expenses while bridging one season to the next, as long as the business maintains sufficient cash flow to comfortably make the periodic payments.
  3. Meeting project start-up costs: Ramping up a new project sometimes requires more capital than what is available from cash flow. A short-term loan could be a good fit for covering expenses that can be recouped in 60 or 90 days.
  4. Emergency repairs: Paying for repairs on equipment that is critical to the operation of your business can be a good reason for a short-term small business loan to help get operations running without a four-year or longer loan obligation.

As a general rule, short-term financing will have a lower total cost, but will likely have a higher periodic payment when compared to a longer-term loan. This dynamic makes it important to understand how that will impact your cash flow. Considering loan purpose before you start looking for a loan will help determine the type of loan best suited for your business need.

READ: A quick guide to startup funding

There are more financing options available to small business owners today than ever, but knowing what makes the most sense for your business isn’t always obvious. In addition to comparing rates, make sure and compare loan terms and total cost of the loan to ensure you have all the information you’ll need to make an informed loan decision.

Accessing capital is a big challenge for many business owners and the current landscape of loan options make it necessary for business owners to become savvier about the options so they can match the right loan with their business need.