Short Line
What’s Better: Business Loans or Business Lines of Credit?
When applying for business funding, one question that many business owners have is; ‘what is better: business loans or business lines of credit?’
The best answer, although not the simplest, is that it depends on the use of those funds.
Business lines of credit are essentially short-term financing based on relatively known payback events like the conversion of assets.
Business loans are more for long-term financing needs such as the purchase of durable assets where payback would results from either the deployment of such assets over a period of time (usually matched to the useful life of the asset) or from efficiencies established from the long-term use of the loan proceeds like increased revenue from expanding markets or the hiring of additional employees to satisfy customer demand.
Think about it this way. You would never go to your bank and inquire about a credit card product when you are in the market to purchase a home.
Credit cards are essentially short-term financing vehicles that should be paid backed almost as soon as they are used – like when you receive your next pay check (essentially leveraging your next income event to get the capital you need or want today).
Most credit card purchases are short-term in nature (like tickets to a show or a night out with the family – items that are consumed immediately without the ability to generate additional income) and thus should be matched to a corresponding loan product – like a short term credit card.
The same is true for business credit. Most business loans or business lines of credit should be matched to the need of the business. Example, a retail home and garden business needs to purchase trees and shrubs now for the up coming spring season where it will sell the bulk of this inventory. There is no sense in applying for a long-term, say a 5 year business loan, as the business will have to again make new purchases next spring.
A short-term seasonal business line of credit would be much better for this business. As the business begins to sell its inventory during the spring and summer seasons, the business will generate the cash flow to repay the advance against the business line of credit – thus matching the sale of those assets to the cash flow or advance from the credit line. Not only will this be cheaper in fees and interest for the business, but, the business will essentially use the assets purchased from the advance to pay for themselves. All that is left over from the sale is profit for the business.
Also, as stated, matching the loan product to a business need can save your business money in the long-run. Think about this. A short-term $100,000 business line of credit for 12 months at 8% interest will cost the borrower about $4,400 in interest. The same amount at the same rate for a 5 year business loan will cost the business some $21,700 in interest.
So, to answer the questions, “what is better: business loans or business lines of credit?’ It really depends on what those funds will be used for.
About the Author
Joseph Lizio holds a MBA in Finance and Entrepreneurship, is the founder of Business Money Today, has a strong commercial lending background and is regarded as an expert in business and finance.
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