Everything You Need to Know About Long Term and Short Term Financing
As you run your business, you may find that you have hiccups in cash flow and gaps in paying bills of various kinds. If you plan on running a business, it’s vital to understand the differences between short term financing vs long term financing.
In this post we’ll talk about short term loans and long term loans,the differences between them, and how they can help you. Learn more about the difference between short term and long term loans below.
What are short term business loans?
Short term business loans means borrowing funds that deal with short term needs or opportunities. Borrowing funds to meet operating expenses and payroll, to purchase new equipment, or funding an advertising campaign are all examples of short-term financing. Generally, short term financing and repayment takes place over the course of one year.
Ironically, what may be considered short term to one business may be long term to another. But short-term loans are more linked to bridging operational needs, as opposed to long term investments. For example, a loan between $10,000 to $50,00 is perfect for most small businesses, who do not require long term financing.
Working capital loans (used to purchase office equipment or hire more staff) or equipment leasing (used for fleet vehicles) are examples of when to borrow short term funds and are examples of short term business finance.These can be approved in 24 hours and can be paid off in a year. This is important to consider when looking at short term vs long term financing.
Do short term loans have higher interest rates? Generally, yes. Since the terms of the loans are not as long, lenders need to charge higher rates in order for their short term loans to be profitable.
What are long term business loans?
Long term financing, or long-term loans, are used for major acquisitions and mergers, building out new factories or real estate, and other large-scale capital projects. These long term loans are the domain of larger businesses, and can take decades to pay back. These kinds of projects can take place over the course of 10 to 30 years, for example.
Matching assets and revenue to liabilities
An important factor to keep in mind is that when borrowing, it’s wise to match cash flows and collateral (assets) to interest payments and liabilities. If this can be correctly done, then a stable foundation can be laid for the growth of the business.
Length of Financing
Another potential pitfall of long term versus short term financing is that while short term interest rates will be higher than long term (as offered by most banks), more interest overall is paid on long term loans since the loan repayment term is longer. Tools such as discounted cash flow analysis can help you and your finance team calculate how much money you will pay on a loan in this year’s dollars, so that you and your team can decide if it makes sense to take a short term loan up front, or to stretch out payment terms. Based on such factors as current assets and project cash flow, this can be a tricky decision. Term length is important to think about when considering short term vs long term loans.
Interest Rates
Whether or not interest rates are trending up or down is a large concern. If interest rates over the course of the decade are trending upwards, even by only a few basis points, then this represents additional interest that must be paid on long term loans. This makes shorter term borrowing more attractive. Interest rates that trend downward, on the other hand, indicate a favorable long term borrowing environment and basis for capital investment.
Loan Supplier or Lender
Long term lenders are also partners. For long term loans, it’s wise to work with a partner, be it a bank or other entity, that understands your business model and business plan, and won’t be alarmed during various events that occur during your normal operations. Developing long term understandings can help ensure that any disruptions to cash flow or repayment schedules are handled smoothly, with each side of the partnership working together to maintain the relationship.
Loan Uses & Applications
As stated before, loans and lines of credit can be used not only for long term capital investment, but as reserve funds to enable operational purchases, account for changes in business conditions, emergency funds and as a cushion during such things as interest rate and currency spikes. This is especially important if your business engages in international trade or in the financial markets and needs temporary purchase or clearance funds.
Long Term vs Short Term Financing: which is better for business?
Well, this depends on lots of factors – how big your business is, whether or not you’re in an expansion phase, how your cash flow works and what your business needs are. But there are a few guidelines that can help:
Quick cash and working capital
Short term loans are best for these needs, as these are expenses that should be paid out of cash flow. Cash flow and regular business should repay these liabilities. These are usually repaid within a year. While rates are higher, you are paying overall less interest due to the short term of the loan. Short term loans have quick approval times, but may be front loaded with fees.
Long term investment and business growth
Long term loans have lower interest rates and lower monthly payments, generally. The longer repayment schedule and lower monthly payments give your business time to ramp up cash flow and stabilize. The drawback is that lenders will more carefully scrutinize your finances and assets, and usually demand collateral of some kind.
Want to Learn More?
Business financing can seem complicated, but we can simplify it for you. At L3 Funding, we’d be happy to discuss with you the ins and outs of long term vs short term financing and what kind of loan is best for your business. Contact us!