Cash flow is the lifeblood of every small business, but when money gets tight or clients are slow to pay, small businesses often need to bridge the gap by having access to a reliable line of credit. Small businesses often borrow money on a short-term basis to enable the company to make payroll, pay bills, and keep the lights on. In addition to this kind of ongoing borrowing to support daily operations, small businesses also need to be able to borrow to expand their facilities, develop new products and invest in longer-term growth.
There is often some confusion among small business owners about their options for getting loans or getting access to credit. If you are considering applying for a revolving line of credit or an installment loan, here are a few key concepts and important differences to keep in mind:
What is Revolving Credit?
Revolving credit, also known as revolving lines of credit, in general, are intended to be used for short-term borrowing. People typically compare a revolving line of credit versus credit card, but lines of credit don’t require you to carry a physical piece of plastic.
Features of a revolving line of credit include:
- Flexibility: With a revolving line of credit, your business has the ability to choose how much you want to borrow at any given time, within a certain limit. For example, you might get approved, based on your business credit score, for a revolving line of credit of $5,000 or $10,000, which means you can borrow up to that amount of money at any time.
- No fixed terms: With a revolving line of credit, you can pay off the amount that you borrow immediately or over time by making minimum payments on the borrowed amount. You don’t have to make a fixed payment each month; you can pay as much or as little as you are able to pay, as long as you pay at least the minimum payment.
- Variable interest rates: With a revolving line of credit, the interest rate that the bank charges you for borrowing money will vary depending on the current market rates. This means that i borrow money from your revolving line of credit and then need to take more time than you’d expected to pay it back, the interest rate might go up (costing you additional money) by the time you pay back the loan.
Revolving lines of credit are a commonly used cash flow management tool for many small businesses. Just be careful to be diligent about paying back your borrowed money promptly; just like personal credit cards, interest payments can add up quickly!
What is an Installment Loan?
Installment loans are usually intended for longer-term, higher-value borrowing – such as capital expenditures, facility expansions, expensive equipment purchases, or any other big-ticket items that a small business needs in order to grow.
A few key aspects of installment loans include:
- Fixed terms: With an installment loan, you are borrowing a specific amount of money upfront and agreeing to pay it back within a certain period of time – such as $100,000 paid back within 5 years (60 months). Typically, a small business installment loan also has a fixed interest rate, so there should not be any unpleasant surprises in that respect. Your lender will work with you to negotiate options for monthly payments and interest rates, which might be affected by whether your loan is secured or unsecured (see below).
- Secured or unsecured: Just like your home mortgage is a “secured loan” that is “secured” (made safer for the bank) by being connected to your property, your business can get a “secured” installment loan that uses some of your business’s property as collateral. Collateral might include your business’s commercial real estate space, business equipment or a company car. Getting a secured small business installment loan will typically result in a lower interest rate. Talk with your lender to see which options are best for you. (NOTE: Some banks also offer a choice of secured revolving lines of credit – enabling you to borrow more money or get a lower interest rate in exchange for putting up some of your business’s property as collateral.)
Basically, an installment loan is kind of like applying for a home mortgage, while a revolving line of credit is more like getting a business credit card. Both of these loans can help your business prosper, but make sure you understand the differences and are getting the right type of financing to meet your specific goals.