In the life of your business, you will need help from the bank for your funding requirements because, at some point, equity is just not going to be enough. To remedy this common problem, you can either get avail of a short-term loan or a long-term loan from banks depending on your requirements.
What Is It?
Before going into the details, you first need to know your foundations, which is the definition of both loans:
A short-term loan is a loan that usually has a tenor of a year or 365 days to fund mainly working capital needs. This also means you have a year to pay off the loan, and that is why it is called a short-term loan.
A long-term loan, on the other hand, is a loan that usually has a tenor of more than 1 year and can last up to 25 years depending on the amount of the loan. Long-term loans are usually used to fund capital expenditures of the company.
What Are The Benefits of Short-Term Loans?
1. Lower Interest
Since you are only borrowing the money for a year or less, banks are exposed to a lower level of risk. With lower risks, this also entails a lower cost of borrowing. Because of this, the interest fees for short term loans are significantly lower compared to long-term debt. If you want lower interest rates, then it’s best to get short term loans.
2. Faster Approval
Short-term loans are usually used for working capital funding needs or as bridging loans. Because of this structure, it’s easier for smaller businesses to get approved for short-term loans. Since it’s also typically a smaller amount with a way lesser tenor as compared to long-term loans, banks give a bigger leeway for this.
3. Easier Documentation and Implementation
Compared to long-term loans, short-term loans have lesser documentation requirements and shorter implementation process. With long-term loans, you usually need to have a term loan agreement and collateral to secure the loan. However, with short-term loans, you don’t need this long agreement. In addition to that, banks don’t usually ask for collateral when you get a short-term loan since it will be paid within a year.
On top of that, implementation for short-term loans have a shorter process as well since the disbursement is usually not as big as long-term loans. So, if you need a credit line to bridge your funding quickly, you might want to opt to apply for short-term loans instead of long term loans.
4. Allowable Repeated Borrowing
One of the short-term credit lines available for businesses is what you call a revolving credit line. A revolving credit line is a line that can be replenished up to the agreed limit as agreed between you and the bank. This means that if you have a revolving credit line worth $10 Million, use up $ 10 Million, and pay $5 Million in 5 days, you can borrow another $5 Million again.
This is not possible with long-term loans. Long-term loans do not give you this flexibility. In fact, long-term loans are very rigid in structure. Usually, long-term loans are granted for a specific purpose, and the loan proceeds should be used for that specific purpose only as stipulated in the agreements. Moreover, unlike a short-term loan, it cannot be rolled over once you make partial payments. You need a grant of a new line to loan from the bank again.
5. Control Your Cash Flows
Another product of the bank with regards to short-term borrowings is receivables financing. Every company has receivables from its customers if they give credit terms to customers. With a bank, they can purchase these receivables and give you the money owed to you by customers earlier than expected. Then, the bank will just get a percentage fee for every invoice purchased by the bank.
By using the receivables financing product of the bank, you will be able to control your cash flows and promote healthy cash flows. You can use these receivables as working capital instead of spending for it out of pocket once again.
Meeting your funding requirements is your goal at the end of the day. It’s helpful to know the difference between the two so that you can choose the right one for you. There are many products that you can use to meet your working capital funding needs. Now that you’ve seen the comparison between the two, you can have a better judgment on which one will really help your business grow.