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As small businesses begin to reemerge during the COVID-19 pandemic, many are facing a cash crunch. After months of no revenue, they find themselves in a position similar to a start-up business. They need an influx of cash to open their doors and to help pay expenses until they can gain some momentum.
Short-term business financing can be the right solution for small businesses in this situation. This type of funding for small business provides a lump sum of money to a company or organization that can use the infusion of cash to help sustain or grow its business.
How Does Short-Term Business Financing Work?
As is the case with a traditional business loan, short-term funding come in a lump-sum payment. The borrower then pays it back within an agreed-upon period of time along with any interest or fees charged.
Short-term business financing can also currently help businesses overcome pandemic-related financial hurdles, cash flow issues and inventory purchases, and get the business back on track faster.
Of all the issues that a small business can face, cash flow may be the biggest and the most common reason for short-term business financing in the U.S. Studies have shown that 82% of U.S.-based small businesses fail due to problems with managing cash flow.
When Would a Business Consider Short-Term Financing?
Outdoor dining is a good example of pandemic-related expenses that a small business can face. While many restaurants welcome the chance to again serve customers on their premises, the establishments also must purchase or rent crash barriers, planters and lighting, sanitizers, disposable utensils, plastic partitions, masks, and other items that are essential to ensure a safe experience for their guests.
Other needs where a short-term financing could be useful for a business include:
- Working capital;
- Building inventory;
- Improved cash flow;
- Equipment purchases;
- Advertising and Marketing.
Short-term financing for small business is meant only to help a business clear a temporary financial hurdle. To that end, they can be an effective part of the financial plan of a small business. But they are not a long-term solution. Proper planning is a critical part of managing the finances of a business. And, if short-term financing is required, it is important to compare short-term business financing to learn which meets the needs of a given business.
Short-Term vs. Long-Term Financing
The main differences between short-term and long-term financing are normally the amount of money received and the length of the repayment terms. Since short-term funding is commonly used to address an immediate need, they tend to come in smaller amounts.
Long-term financing amounts are greater because they are normally used for projects or investments that are designed to take place over a longer period of time. As a result, the repayment period is also longer. Depending on the lender, the repayment period can be anywhere from one to 25 years.
Because of their lengthier repayment terms, long-term loans tend to have lower interest rates than short-term loans. Short-term business loan rates are higher due to the smaller timeline for repayment.
Advantages of Short-Term Business financing
Even though the interest rates on short-term business financing may be higher, the length the funding agreement creates significantly less time to accrue interest. As a result, the amount of total interest paid can be significantly less.
Since short-term business financing tend to be for smaller amounts, the requirements for approval are typically easier to meet since there is less risk involved. This lower risk also reduces the amount of time involved in getting access to funding.
How Long Is Short-Term Business Financing?
Short-term loans get their name since they have to be paid off so quickly. For a typical short-term loan, the repayment period is typically 18 months or less. Most short-term loans, in fact, must be paid off within six months to a year. Most short-term loan lenders can fund a business within 24 hours after approval.
There are short-term business funding products with term lengths as short as six months, and some that do not have fixed terms at all. These typically include:
Who Can Qualify for a Short-Term Business Loan?
The qualifications for a short-term business loan are not nearly as stringent as long-term loans. Any business that makes at least $100,000 in gross annual sales and has been in business at least six months can qualify for a short-term business financing. No minimum credit score is required for some on-line lenders. In fact, many online lenders emphasize cash flow over the traditional business financials required for long-term loans. This is due primarily to the shorter repayment period.
What is the Most Popular Form of Short-Term Business Financing?
Short-term loans and business lines of credit are the most common types of short-term financing vehicles. But short-term business financing does not involve a one-size-fits-all approach. As a result, proper short-term financing is based on the needs of an individual business, not popularity.
No matter the type of loan, there are other factors to consider when deciding what type of financing works best for a business. The reason why a given business is looking for financing is a crucial component in proper financing. In addition, the lender from which a business gets a loan can be just as important as what type of loan it is getting. Businesses may also look at alternatives to loans that may be better suited to their needs.
Types of Short-Term Business Financing
Short-Term Loans: First of all, short-term loans sometimes are confused with payday loans. They are not. Rather, these loans offer of lump-sum fixed amount up front. Repayment is typically within one to two years. Instead of an interest rate, a “factor” rate, otherwise known as a fixed cost of money, is charged for most short-term loans. This rate can be anywhere from 6% percent (a 1.06 factor rate) to 35% percent (a 1.35 factor rate). Origination fees can fall between zero and 3 percent.
Bridge loans are one common example of a short-term business loan.
For small business owners who ask themselves, “Can I get a short-term business loan with bad credit?” The answer, fortunately, is yes. Applicants for short-term loans may be asked to provide certain documentation and credit scores, although low credit scores are not necessarily a deal-breaker when it comes to getting approved. Documentation requirements can also be less rigid. These loans are processed quickly. In fact, funding can be received within 24 hours. As such, short-term loans are a great option for businesses that cannot get approved a more traditional loan.
Equipment rentals are an example of a where a short-term loan can be a better option than a long-term loan for an equipment purchase. A trash hauler, for instance, may lose a truck to repair and need to fill the void for several weeks. In this situation, using a short-term loan to pay for a rental is a more cost-efficient option than purchasing a new truck.
The payment schedule for a short-term loan can be weekly or bi-weekly. While terms can range from six to 18 months, they tend to be 12 months or less.
Business Line of Credit: This option is an open revolving line of credit that allows borrowers to withdraw funds as needed and to make purchases up to a pre-determined limit. Business lines of credit make it easier to access funds than other short-term funding options. They charge principal and interest rate, and typically need to be renewed annually or semi-annually.
Interest rates start at the treasury index rate plus one percent up to 2.5 percent. Origination fees can range from range from zero to three percent, and payment schedules can be weekly, bi-weekly, or monthly. Lenders normally prefer good to excellent credit scores in order for a business to qualify for a business line of credit. One of the difficulties with many line of credit products is that the lenders that make these products available often will only offer them to specific kinds of businesses due to strict credit requirements and personal guarantees by the business owner. If your business doesn’t fall into one of the preferred industries, you may not be able to secure this type of product.
Vendor Credit: This type of short-term loan is also known as supplier credit and can be helpful in managing cash flow. This option requires a business to set up a credit arrangement with one or more of its vendors. Such an arrangement will give a business an agreed-upon period of time to pay for a product or service instead of having to pay cash on delivery. Payment terms can commonly be negotiated as net 30, 45 or 60 days.
This arrangement absolves a business of paying interest as long as it makes its scheduled payments on time. A business can also earn a discount by paying early, if such a setup is agreed upon.
Vendor credit is one of the more valuable short-term loans for a business since it allows a business to turn a profit on the funds it borrows in order to make its payments to the lender.
Business Cash Advance (BCA): A business cash advance provides funds that are projected to be earned from future sales. That’s why they are also known as future sales agreements. Under this scenario, borrowers receive an advance on their future sales, and agree to pay back a specified amount that is greater than the amount they are advanced. The difference between the amount advances and the amount charged is known as the factor rate. This term can be misleading, as the factor rate is actually a flat fixed cost of the money and does not operate as an interest rate does.
In addition, BCAs charge an origination fee of anywhere from zero to three percent. Payments may be made weekly or daily, Monday through Friday, through ACH payments. Credit requirements can be flexible, and funds can be available within 48 hours.
Merchant Cash Advances (MCA): A merchant cash advance involves the purchase of a future sale agreement. MCAs are similar to BCAs, but their repayment process is different. Since MCAs are tied to future credit card sales instead of total sales overall, they take a percentage of future credit card sales until the advance is paid back in full. The absence of a fixed pre-determined payment offers the borrower greater repayment flexibility. For instance, there is no set period of time in which the advance needs to be paid in full.
Factor rates for MCAs range from 1.09 to 1.45, while origination fees fall between zero and 3%. Credit requirements can be lenient. In some instances, funds can be available the same day that the application is made. Processing can otherwise take between 24-48 hours.
Invoice Financing: For business owners that are desperate for a quick influx of cash, invoice financing, which is also known as invoice factoring, can be the way to go. Invoice financing provides the borrower with an advance based on invoices that the borrower has on the books as accounts receivable but has yet to collect. As a result, the borrower gets cash much quicker than waiting for the invoice to be paid, and no longer has to concern itself with getting the invoice paid.
The invoice financing company pays off the invoice for a fee that is typically one to three percent of the invoice and assumes the responsibility of its collection. There can also be an origination fee of zero to 3%, and monthly service fees depending on the number of invoices that are factored.
There are no credit requirements for the business owner receiving the advances. But the credit of the clients who must pay the invoice has to be acceptable. Invoice financing generally takes about a week to put in place. After that, advances can be paid with each successive invoice.
Purchase Order (P.O.) Financing: This option can be a good fit for growing businesses that want to fill large orders but may not have enough working capital to do so. Purchase Order financing provides capital to pay suppliers upfront for verified purchase orders. This allows business to avoid depleting their cash reserves, or from having to decline an order due to cash flow problems.
In this scenario, the financing company pays the suppliers directly and the order is shipped to the business. The company may finance all or part of the purchase order, advancing funds to the supplier. Once the order ships, the financing company collects payment from its customer, subtracts its fees and pays the balance of the invoice.
Purchase order financing can be set up in a few days to a week. Fees range between one and six percent of the amount of the purchase order, depending on the risk involved. All parties involved need to have a good credit score.
Business Credit Cards: A business credit card is the best option for meeting the purchasing needs of a company on demand. They are open revolving lines of credit, charging principle and interest with a credit limit. Business credit card operate much the same as personal cards. Applicants must have credit scores of good to excellent. Annual fees could be as much as $500. Same day approval is available, but you often have to wait to receive the card before you can activate the account and start using the available credit limit.
What is a Short-Term Business Loan Calculator?
A short-term business loan calculator is a tool that a small business can use to estimate its total payment, interest rate or effective annual percentage rate (APR), total repayment amount and any other information that it needs to decide between loan offers. The calculator can help a business determine the true cost of a business loan.
The amount of the loan, the payback amount or factor rate, the origination fee, the frequency of repayment, the number of payments and any maintenance fees that may be charged are inputted into the loan calculator.
Lenders may charge a number of fees in addition to interest rates. Such fees may include:
- Origination fees;
- Closing fees;
- Application fees;
- Packaging fees;
- Referral fees;
- Guarantee fees;
- Assessment fees;
- Prepayment penalties and others.
From this, it calculates the total repayment of the business, the amount of its periodic payments, the effective APR, its financing cost, and cents on the dollar. The financing cost is the total amount that borrower is paying in fees other than origination fees and miscellaneous fees. The cents on the dollar is the total amount paid in fees for every dollar borrowed. The total repayment, financing cost and cents on the dollar reveal the true cost of borrowing.
Short-Term Loans for a Startup Business
There are a number of ways to funding a startup business, many of which involve using the personal funds of the business owner, their family or, in the case of crowdfunding, total strangers. But startups can also qualify for a short-term loan. But, because startups do not have the same financial history of their more established counterparts, they may have to put up collateral to offset the additional risk.
The process of qualifying for short-term business financing typically comes with more relaxed standards for all applicants. But it’s not unusual for startups to provide assets such as real estate, equipment, personal property or accounts receivable as collateral to back up the loan. Term lengths can be as short as six months.
In the case of using accounts receivable as collateral, this is basically the same as financing through invoice factoring and is a way to avoid the high interest rates that can be associated with other short-term lending options.
Getting Short-Term Business Financing with Bad Credit
Bad credit further complicates the process of getting a short-term business funding. But many alternative lenders will consider applicants with bad credit, a low score will usually restrict the options available to applicants. One way a small business can gain an edge in the application process is to understand how its business credit score is calculated, and the weight that each factor is given. Payment history, amounts owed, account history, new credit and credit mix are among the criteria that make up a credit score.