Short term loan refers to the funds that your business can borrow from a bank or an alternative lender for a short period of time. The repayment period can vary from very short such as a month to around 18 months. Most short term loans, however, will have a maturity of one year or less which means they must be repaid within one year.
The repayment schedule of a short term loan will vary depending on the loan provider and the deal structure. It can be daily, weekly, monthly or, in the case of a very short term loan you may even repay it as a lump sum at the end of the term.
Short term loans help small businesses meet an immediate need for financing without requiring them to make a long-term commitment as in the case of a long term loan.
They are usually used to finance temporary working capital needs or to bridge the temporary financing gap. Typical candidates would be:
- A business with seasonal fluctuation where short term loans can help bridge seasonal gaps. However, you should be aware that some lenders require payments daily or weekly as opposed to monthly. Although these payments are smaller, their frequency can be an issue for businesses that have uneven sales or don’t always hold much cash in their bank account.
- A construction business which deals with projects that have an uneven cash flow profile: a large cash outlay at the beginning of the project with the major part of the cash inflow coming at the end of the project
- New business with shorter financial history and/or lower credit standing
- A business that needs to build inventory quickly in order to meet rising demand
- A business with an unexpected repair cost or tax bill or other type of emergency
Differences Between Short Term and Long Term Business Loans
There are three key differences between short term and long term loans and these will have implications for their respective benefits and disadvantages:
- Maturity: Because of the shorter maturity short term loans may prove more favorable in terms of the total dollar amount paid for interest compared to long term loans. With long term loans, you may end up paying more interest since the interest had more time to accrue. This will depend on the rates in each individual case, so make sure to do the calculation for each individual case of loans before deciding.
- Interest rate is typically higher with short term loans. This is because short term loans provide quick access to capital, but also to compensate for the shorter repayment period and for usually lower credit standing of borrowers.
- Application process and qualification standards: Short term loans can provide funds in as little as 24 hours. They are easier to qualify for because shorter repayment term means that lenders are more willing to take the risk with a borrower with weaker credit. This will be reflected in higher interested, though. Because of the speed and ease, short-term business loans can lead to becoming too reliant on this form of financing. You can end up rolling the short term debt over instead of paying it in full. Given the generally higher rates, this can prove very costly.
- Loan amount: As a general rule, the higher the loan amount, the longer it will take to repay it. Short term loans are therefore typically smaller.
Things to Consider
Whether your business will benefit or not from a short term loan will depend on a number of factors which you should carefully consider before making a final decision:
- What is the purpose of the funds that you want to borrow?
This will be the most important question when considering short term loan.
If you need money for the long term, a short term loan is not suitable form of financing. This type of lending is expensive compared to long term loans. You need to be very clear how long you will need to borrow the money for and not underestimate how long it will take your business to pay the loan back. If you miscalculate this and as a result end up rolling short term debt over, you will effectively have long term commitment just as in the case of a long term loan, but at a much higher rate.
Short term financing in an asset or a project which will pay off in medium or long term will not make financial sense as you may not have enough funds to make debt repayments before your investments starts paying off. This is called maturity mismatch and you should be aware of this risk. Conversely, taking out a short-term business loan to finance a quick turnaround project or inventory will make financial sense to do.
- How much money you need and how quickly you need the funds?
Larger amounts are more suitable for long term loans as the repayment amount is spread over longer period and thus will not become too much of a burden for your business.
But, if you need quick cash, short term loan is more accessible alternative.
- Interest rates and term
If you need quick money for short period, short term loan make more sense. Make sure that your business can sustain higher payments that come with short term loans.
- What other financing options you have?
Your business’ overall financial health will determine whether you have a full array of financing options. If you don’t qualify for more favorable ones, then short term loans can have advantages, especially relative to other short-term funding options. If you need access to various funding options, our website provides a comprehensive list of small business loans as well as alternative financing solutions such as business growth funding or R&D funding.
Short term loans are provided both by traditional and alternative lenders, although the alternative online market is growing rapidly. As a general rule, traditional lenders like brick and mortar banks will have better rates compared to online lenders, but will have more strict requirements and longer application procedures. If your business can document several years of stable financial track record, you can leverage your good credit profile and apply for one of these loans.