When your business grows or goes through a short-term cash drought, you need an influx of cash. The bank is the best place to start. They give you two options a loan or a line of credit. It can be hard for a business to decide loans vs. line of credit.
They both can give you the cash you need, but each is different on how the cash gets to you and how you pay it back. As a business owner, you don’t want to make a rash decision that can impact your business for years.
We’ve broken them down and given you plenty of information to determine which is best for you.
Line of Credit Basics
A line of credit isn’t a loan. It’s like a credit card with a limit. When you apply for a line of credit, the bank gives you a set amount that you can have access to. You don’t need to take a penny of it. It can sit there ready to use when needed.
When you decide to take it, you don’t need to take the entire amount. For example, if you had a run on a popular product, but don’t have the cash flow to order more, then you can access your line of credit.
You have a $10,000 line of credit, but only need $200 to cover the costs of the product. You take the money out and then you agree to pay back that amount plus any interest.
In the meantime, your accessible line of credit is $9,800 until the money is paid back. You then have access to the full $10,000 again.
It’s rare for a business to take out a full amount and instead to take out small amounts when needed.
Benefits of Line of Credit
Financially, the biggest benefit is you don’t need to pay anything until you take the money out. You’re not locked into a monthly payment and you only need to pay the money back that you took out with a little interest.
These are geared more as a short-term loan that is paid back in a few months rather than a multi-year loan. They are commonly referred to as a revolving loan and have lower interest rates than a term loan of similar size.
If you are late on payments, then that rate can increase dramatically, and you can incur fees.
It’s also great to save for an emergency such as a sudden building repair or an increase in product price. Lines of credit are popular with small business that can’t come up the cash fast when a new opportunity arises.
A standard business loan is like a standard loan. You visit the bank and request to borrow a specific amount of money. There is a purpose associated with the loan such as the purchase of a building, fleet of cars, expansion, etc.
The bank examines your credit and balances the risks and benefits before determining to allow the loan. Once approved, you work on the length of the loan, interest, payment amount and are given a lump sum of money.
For example, your current building isn’t large enough for your burgeoning and growing business.
You can get a term loan to pay for a new larger facility and moving expenses. It can also go for equipment such as a new oven for a cookie company or new equipment that you use to create a new product.
You pay it back monthly at a set interest rate until loan agreement is fulfilled. They are traditionally used for more long-term investments.
Benefits of Term Loans
The biggest benefit of a term loan is predictability. You know each month you’ll owe the bank a set amount. There’re no worries about that amount changing or the amount owe going up or down. The rate of interest is the same for the life of the loan.
The biggest downside is you likely provided some type of collateral on the loan. If you can’t pay back the loan, then the bank can take that collateral. Keep that in mind when you’re determining your monthly payment amount.
If you pay more, then you can pay towards the principal and lessen the amount of term of the loan. You can do with what you want with the money as soon as you receive it.
Loan vs. Line of Credit
So, you know what the differences are between the two, but which one is the best for your business. It all depends on what you want to do with it.
Lines of credit aren’t meant to be long-term loans. They’re there for an emergency or small thing that didn’t fit into the budget. You need $3,000 for a new furnace or the refrigerators for your produce died. This is something that would probably be better applied to, or paid with credit cards.
It’s not meant for something large like a new building. It can be used for payroll, off-season costs, and restocking inventory. If you use for money-making ventures, then it can end up paying for itself.
Businesses use lines of credit for small purchases a little at a time. Don’t take one out and grab the whole amount at once. You likely need a business loan. It’s easy to learn why if you carefully examine the pros and cons of each method.
If your need is high cost and can take years to pay back, a business loan works best. You get a large lump sum to purchase a new building or other major expense like equipment and pay it back over time.
Which is Best for You?
Ultimately, you need to decide which one is the best for your business needs. Loans vs. line of credit can be a difficult decision, but hopefully, we’ve made it easier for you to choose.
Loans are best for long-term high-cost expenses, but lines of credit are best for short-term expenses and emergencies. What is your business looking for?
If you’re interested in learning more about money and how you can improve your business, then please explore our site.
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