Short-Term Business Loans

There are all sorts of reasons why you might need a quick cash injection for your business, and many SMEs decide to seek short-term finance at some point. It could be that you need to upgrade your equipment or take advantage of an exciting expansion opportunity – or simply to provide a buffer in case of unexpected expenses or fluctuations in your cash flow.

There are several types of short-term business finance available, and the right option for your business will depend on your circumstances as well as the reason you’re seeking funds.

Here are the top five most popular options.

Top five most common types of short-term business loans

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Unsecured business loan

An unsecured business loan is the most straightforward type of short-time finance, which is why it is so popular with SMEs. In today’s busy alternative finance market there are scores of online lenders who offer unsecured business loans on a wide range of terms to businesses that may not qualify for bank finance, or do not have assets to offer as security.

The ease of application can make these alternative lenders attractive even for well-established businesses that do meet the banks’ strict criteria – for some business owners, the speed of access to funds can outweigh the additional cost.

An unsecured business loan will be for an agreed term (typically 3 – 12 months), with regular repayments on a schedule agreed with your lender. You may be able to structure your repayments to suit your cash flow, which is great for seasonal businesses.

The cost of an unsecured short-term loan will depend on several factors, including the amount you wish to borrow, the term of the loan, and your risk profile. Typically, the interest will be higher than you could expect for a secured loan, and the higher the risk you pose to the lender, the more you can expect to pay.

You may be expected to provide a personal guarantee of the business loan, which could put your home or other personal assets at risk if your business is forced to default on payments.
Be aware that fintech lenders are not regulated in the same way as high-street banks, and many lenders have additional fees and charges. Failure to keep up with interest repayments, for example, may attract hefty fees which can quickly mount up. Be sure to check all the fees and costs, as well as other terms and conditions, when comparing loan options.

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Business credit card

A business credit card is extremely useful for many SMEs, as it enables online purchases and offers an easy way to make smaller purchases – such as low-value equipment, consumables, travel or office supplies – without worrying about petty cash.

Some business credit cards have incentive or reward schemes (such as travel discounts or perks, discounts on specific purchases or benefits like built-in insurance) which can improve their value, provided that you don’t pay more in fees than you reap in rewards! Economy or low-cost credit cards do not usually offer incentives, but with these you can expect to make savings in both fees and interest rates.

Most business credit cards offer an interest-free period on purchases, which means that, provided you use your card with care, you’ll be able to delay payment on purchases at no cost. The key is to make sure you always pay off your full balance by the end of the interest-free period – if you do not, you’ll be charged interest from the day you made your purchases.

Credit card interest rates are generally extremely high, so if you are not able to pay off your full credit card balance you’ll end up paying dearly for your finance.

On top of the interest rate, most cards have annual administration fees, and some may have additional fees and charges (like late payment fees), so it’s important to make sure you’re aware of the full cost of each option when comparing business credit cards.

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Business overdraft

Just like a personal overdraft, a business overdraft is facility attached to your bank account that allows you to access funds up to an agreed limit. You can use, repay and reuse the funds as long as the facility remains in place.

You’ll only pay interest on any funds you use, calculated daily based on your balance, but paid monthly – so it’s a great way to provide a buffer in case of emergencies, or as a fall-back to cover regular outgoings if your working capital fluctuates, without having to take out a loan and pay interest on funds you don’t always need. (Use our business loan calculator)

There is likely to be a fee for your overdraft facility – and the interest rate is likely to be high compared to an unsecured loan, as you’re paying for the convenience and flexibility.

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Line of credit

Unlike an overdraft, a line of credit will be separate to your trading account, so you can access it even when you have cash available in your account. In many other ways, though, it is similar to an overdraft – you’ll have an approved credit limit and you’ll be able to draw down funds as you need them, up to that limit, without having to get further approval from the lender.

A line of credit may be:

  • Fixed – you can draw down the funds once, in a lump sum or in instalments over time, and then you’ll need to repay them by the time the facility expires.
  • Revolving – you can draw down, repay and redraw the funds as often as you need within the agreed period.

Some alternative lenders are willing to offer an unsecured line of credit of up to $50,000, while others – particularly high street banks – will require you to offer property, equipment or even liquid assets (e.g. stock) as security.

Expect to pay an initial application fee, and in some cases a monthly service fee, for your facility, plus interest (calculated daily) on the amount of funds you’ve drawn down.

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Factoring

Offering credit terms can be a good incentive to customers, but it can leave you with a major cash-flow headache, since regular bills like utilities, wages and tax won’t wait for your invoices to be paid. Factoring, also known as invoice finance or accounts receivable finance, allows you to unlock the funds that are tied up in unpaid invoices.

It’s a popular method of accessing cash without borrowing, but it does have a drawback – once you sell the invoice, you lose control of the relationship with your customer. If they have a bad experience at the hands of the factoring company, you may lose their custom.

Here’s how it works:

  • You’ll sell your unpaid invoices to a factoring company, who will advance you 70% – 90% of the amount owed, giving you an immediate cash injection.
  • The factoring company will collect payment when the invoice is due.
  • After the customer has paid, the factoring company will deduct a fee and then pay you the remaining balance.

There are two types of factoring: recourse, where the factoring company has the right to sell you back the invoice if the customer does not pay, and non-recourse, where the factoring company takes on the full risk of collection. As you can imagine, non-recourse factoring is likely to be more expensive, and less easy to access.

Some factoring companies will allow you total flexibility (‘spot factoring’), so you can pick and choose which, and how many, invoices you sell. Others will expect a package deal (‘whole-ledge factoring’), where you must sell all your invoices, an agreed number of invoices each month, or all invoices for specific customers.

They may also want to pick and choose which customers’ invoices they are willing to buy – and for obvious reasons, the credit-worthiness of your clients will be an important factor in whether or not a lender will be willing to offer you factoring services, and the fees they’ll charge.

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The fundamental rule of short-term business finance

Never use a short-term facility to finance a long-term, high-value purchase like property, vehicles or plant – not only will you pay far more than for a long-term loan secured on the asset, but you’ll run the serious risk that your finance will expire long before you are able to repay the loan.

Short-term finance is all about convenience and flexibility. In exchange for that flexibility you’ll pay higher fees, and you’ll have no certainty that finance will still be available to you at the end of the term. Even ongoing facilities like a business credit card or business overdraft can be withdrawn at any time.

Short-term finance is always more expensive, especially facilities like a line of credit where funds are tied up even when you are not using and paying interest on them. Lenders will charge higher fees and rates to compensate them for losing the guaranteed interest and the benefits of compounding over time. See the entire range of small business loans.

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Top five most common types of short-term business loans

Here’s a handy overview of the top five short-term business finance products:

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Unsecured business loan

A standard short-term loan, usually for a term of 3 – 12 months, repaid in regular instalments on a schedule agreed with your lender. No assets are required as security, but you may need to provide a personal guarantee. Usually taken out to finance a specific purchase.

Overdraft facility

A flexible facility attached to your trading account that allows you to access funds up to an agreed limit. You can use, repay and redraw the funds as often as required. You can expect to pay a facility fee and interest on funds you borrow, calculated daily but paid monthly.

Business credit card

A business credit card provides easy access to online or in-store shopping and enables you to delay payment for consumables and low-value purchases. Interest-free periods can make this an economical form of back-up finance provided that you repay the full balance each month when due.

Lines of credit

Similar to an overdraft but separate from your trading account, a line of credit gives you instant access to funds up to the agreed limit. On a revolving facility you can draw, repay and redraw funds as often as you need. You’ll pay a facility fee plus interest on the funds you use, calculated daily.

Factoring

A convenient, but expensive, way to access cash without borrowing, by selling your accounts receivable to a third party. You’ll receive an advance of 70% – 90% of the value of each invoice, and the factoring company will take responsibility for collecting payment from your customer. Once they receive payment they’ll send you the balance of the funds, less their fee.

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