Running and growing a small business demands uninterrupted cash flow throughout its journey. Inadequate liquidity can stunt, cripple or kill one’s business within a short period of time. When you feel that your business needs financial boosting, generally you will have two options to choose from. First one is a Small Business Loan and the second one is Line of Credit. Both undoubtedly are the credit instruments meant exclusively for business and this only is the reason behind the dilemma of most of the small business owners. Most of the business owners find it difficult to choose the right credit product. If we study both of these credit instruments carefully, we can find a number of features which distinguishes both from each other. Let’s review these two useful financial tools to make our choice well-defined whenever we are about to take a credit for our business.
What Is a Business Loan?
A business loan is a term loan where you take a lump sum amount at once. Such loans generally come with fixed interest rate and fixed tenure. The lender and the borrower make an agreement that the borrower will be paying a specific amount of money until the tenure ends. Such loans can be repaid in monthly, quarterly, half yearly or annual installments. Most of the business loans are provided at a fixed interest rate, although variable rate loans are available. Business loans are secured loans and the loan amount depends on both the repayment capacity and the value of the collateralized asset. Some of the examples of a business loan collaterals are borrower’s business assets, such as real estate, equipment or inventory, the residential property of the borrower etc. Availing a business loan becomes easy if your business has a long track record and an excellent credit history.
Pros and Cons of a Business Loan
Pros
Lump-sum Amount
Business loans are best if you need a big amount at a time. When you want to invest your loan amount in purchasing inventory, types of equipment or expanding your business to a new outlet or a branch office, a business loan is a perfect solution.
A Prefixed Amount to Be Paid
As business loans are installment loans like a home loan or a personal loan, the borrower has to pay a fixed amount on a fixed interval of time. The borrower can be financially disciplined over the loan repayments as the EMI amount is fixed.
Fixed or Variable Rate of Interest
In a business loan, the borrower has an option to choose between a fixed or variable interest rate. One can choose any of the both after having a good market study.
Flexible Repayment Plans
As mentioned above, the repayment of a business loan can be done in flexible intervals. Unlike a home loan or personal loan where the installment goes monthly by default, here in the business loan you will have options to choose exactly how much you pay back and when. You could pay your loan back with monthly installments, quarterly installments or half-yearly installments or annual payments.
Cons
Getting A High Amount Is Difficult
Getting a high amount in a business loan is a tough task. The lender checks the eligibility in various aspects before sanctioning the loan. Even if you are eligible, you may not get the loan if your business plan cannot satisfy the lender.
Can’t Help with Cash Flow
The business loan can’t much provide help in cash flow of the business. As you receive the amount at once, it can’t provide you with a protection against the unexpected emergencies.
Inflexible
With a business loan, repayments start immediately from the following month and you are hooked for the amount you borrow. You will have to pay the EMIs even if you don’t end up using all of it.
The Best Uses a Business Loan
Business loans are best used when you need a one-time investment of a large amount. One can own some asset for the business by a good utilization of a business loan. Some of the ideal uses of a business loan are-
- Purchasing Equipment
- Financing Real estate
- Financing Vehicles
- Business acquisition
- Leasehold improvements
- Purchasing computer hardware or software
- Purchasing inventory
What is a Business Line Of Credit?
A business line of credit is a revolving credit just like a credit card. This is an agreement between the lending institution and the individual. Here the lender assures the individual to borrow a certain amount of money which the borrower can take in small parts whenever there is a need. The borrower has to pay interest on the amount that has been withdrawn, not the whole amount. The borrower can maintain the balance by repaying the amount that has been withdrawn. A borrower can access funds from the line of credit as long as he wants till the maximum amount don’t exceed. One has to do the minimum payments every month to avoid paying a higher interest rate. The business line of credits are generally used for longer durations like 10 to 15 years.
Pros and Cons Of A Business Line Of Credit
Pros
Only Pay Interest on What You have Accessed
Unlike a business loan, one has to pay interest only on the amount that has been withdrawn. The credit burden will be of only the amount which you have used instead of the whole lump-sum amount.
Provision to Renew
The line of credit loans are the renewable forms of credit. One can withdraw money and pay it back which maintains the balance as well as renews the line of credit for future.
Make Withdrawals at Any Time
If you have renewed your business line of credit and have a balance in it, you can withdraw any amount within the limit at any time. One can use the same for the daily expenses of a business or keep the balance safe to use in emergencies.
Manage Financial Uncertainties with a Personal Line Of Credit
Cons
Not a Good Option For Large Purchases
A line of credit may not be suitable if you want large purchases. Such expenses need a large amount to be spent at once. There is no point in taking a line of credit and use the balance at once. If you do so, you will not be able to enjoy the convenience of a line of credit till you pay off the amount taken.
Unpredictable Repayment Amount
Unlike a business loan, you can’t be assured of the repayment amount of your line of credit loan. The payable depends on the amount you have used each month. So, making a budget is difficult with the repayments of a line of credit loan.
Charges On Withdrawals
Some of the lenders may impose a withdrawal charge every time you withdraw funds from your line of credit. It means as many times as you withdraw, you will have to pay a fee for the same.
How Can You Use A Business Line Of Credit
The business lines of credits are best used as emergency funds. Here are some other uses of this kind of credit-
- Managing the costs during an offseason
- Payroll
- Emergency expenses
- Paying due bills
- Covering expansion costs
The Differences Between a Business Loan and Business Line Of Credit
One of the basic differences between a business loan and line of credit loan is the way we receive the fund. In a business loan, we receive the fund at once whereas the fund with a business line of credit can be received in a number of small parts. Just like receiving the fund, repayment method is also different. In a business loan, you are to pay a fixed amount of money every month. The repayment of a line of credit may vary from month to month depending on the amount used and the interest rate as well. The line of credit loans are revolving credit and not set for paying back the whole credited amount at any certain time frame.
A borrower can even find a difference in the fees and charges of both kinds of credits. The fees which we are to pay for a business loan include a processing fee, a credit check fee, and an appraisal fee if the loan was a secured loan. In another hand, the fees which are to be paid for a line of credit are a processing fee, credit fee, Withdrawal fee which is charged each time the borrower draws out additional cash against the line of credit.
Which Makes More Sense: A Business Loan or a Line of Credit?
To find out the better way of financing, one has to evaluate the need for money. If you need money which is to be used at once then it is better to opt for a business loan. By availing a business loan, you will be assured of paying off the loan by a certain time frame. In another hand, if you need some extra fund for an uninterrupted cash flow in your business or you are uncertain about the amount you are going to need, then a line of credit is the best option that can be ever found.
