Short-Term Financing: How to Get it For Your Business
When unexpected business expenses arise, you may not always have funds readily available to cover them. Obtaining short-term financing could be a way to quickly get the money you need to keep your business moving.
What is short-term financing?
Short-term financing is typically a loan or form of credit that needs to be paid off in less than a year, said Brian L. Thompson, CPA and past president of the National Society of Accountants. Short-term financing is usually available in smaller amounts than standard term loans and often has higher interest rates.
Business owners could take on short-term financing if they’re confident they will generate enough capital to pay off the debt quickly, Thompson said. For example, if a customer made a large order but won’t pay you for four or five months, you could get a short-term loan to cover the cost of filling the order knowing you’ll have the money to pay the debt when your customer pays you.
Short-term financing can also be useful when your cash flow fluctuates, he said. If you’re experiencing a seasonal dip in funds, you could borrow money to hold you over until your cash flow picks back up.
“You’ve got short-term financing to get you through those lean months,” Thompson said.
When reviewing your application for short-term financing, a lender looks at your personal credit score, business credit profile, cash flow, time in business and annual revenue. Each lender has its own minimum requirements for business owners looking for short-term funding.
Types of short-term financing
When shopping for short-term financing, there are a few types you may come across.
Short-term business loans can cover any unexpected business expenses, such as a decrease in cash flow or equipment repairs. Short-term loans often come in small amounts and have shorter repayment periods and higher interest rates than long-term loans. However, the approval process is typically fast and requires little paperwork, and some lenders may consider applicants with poor credit. Short-term loans must often be paid back within three to 18 months, and borrowers may be required to make daily or weekly payments.
Business line of credit
A business line of credit allows business owners to withdraw funds up to a set limit. You could use this money to purchase inventory, hire employees or cover unexpected expenses. Once you’ve paid off what you borrowed, the full line becomes available again. With a business line of credit, money is available to you on an as-needed basis and interest only applies to the amount you actually borrowed. However, the interest rate depends on your personal credit and the state of your business, and the rate may be high if you’re a low-credit applicant. You may also have to provide a personal guarantee to secure a business line of credit.
Invoice factoring, also called accounts receivable financing, is a low-risk option that relies on your invoices as collateral for financing. A financing company buys your invoices in exchange for capital, then collects repayments directly from invoices once they are paid. Invoice factoring does not require additional collateral, and you could receive cash right away to cover business expenses. However, invoice factoring is more costly than some other financing options, as factoring companies typically charge high fees.
Merchant cash advance
A merchant cash advance allows a business owner to receive a lump sum of funding in exchange for a portion of their future receivables. A merchant cash advance company typically buys a percentage of your business’s credit card sales and makes a deduction from each transaction until the advance is repaid. Payments on merchant cash advances are usually made daily and are higher on days when the business makes higher revenue. Business owners can typically secure approval for a merchant cash advance right away, but fast repayment terms and high fees make it a risky financing option.
Short-term financing: Pros and cons
|Quick way to fill cash flow gaps||Underwriting process could slow down time to funding|
|Debt is paid off fast||Payments could impact your daily working capital|
|Helps you continue operating your business||Funding amounts are low with high interest rates|
Is short-term financing right for you?
Short-term financing can help you cover temporary cash shortages or emergency expenses. If you need a piece of equipment or materials to complete a project, short-term financing options can help you get what you need to keep your business running smoothly, Thompson said.
“It allows you to purchase the things that you need to continue doing business,” he said.
When you take on short-term financing, you should make sure you’ll be able to follow a fast repayment schedule, Thompson said. You may be required to make daily or weekly payments, which could reduce your regular working capital. Your business needs to be stable enough to support all your expenses.
“Your working capital number is lower because of the obligation that you have to pay off that debt in a short amount of time,” Thompson said.
Because terms are brief, interest rates for short-term funding are generally high, which increases your debt. Before signing on, you should make sure you can handle the total amount you would owe.
When it comes to which type of short-term financing to choose, think about how much you need and why you need it, Thompson said. If you need one-time funding to pay for inventory, then a short-term loan might be the best option to cover a single purchase.
However, if you find your business regularly running into cash flow problems during a certain time of year, you may want to open a business line of credit, Thompson said. A line of credit gives you ongoing access to the funds you may need to bridge brief gaps in cash flow.
The immediacy of your funding needs is also an important factor, Thompson said. Applying for a short-term loan could be time-consuming, and the loan underwriting process could delay the time to funding. If you have a line of credit readily available, you could get your funds quicker. Merchant cash advance providers generally offer an easy application process and fast funding, though such conveniences come at a high cost.
You may also want to consider turning to a financial institution with which you have a relationship. You may have a better chance of being approved for funding if the lender is already familiar with your financial history, Thompson said. When applying for a small business loan, you should do all you can to increase your chances of approval.
“It’s not always an easy process to get a loan, and it’s not always a guarantee,” Thompson said.