Common Small Business Financing Terms Defined
That’s why you should conduct research beforehand, so you can explore your options with confidence. Soon, you’ll discover that while small business funding is a fairly complex topic, the basics are easy enough to grasp. Start your research with this list of some of the most common small business financing terms.
If you are interested in this topic, we wrote an extensive guide about Small Business Loans that you should check out!
Defining Common Small Business Financing Terms:
These basic terms are what every small business owner needs to know before applying for a loan. Understanding these terms will ensure you’ll make the best financing decision for your business. If you’re having trouble understanding a concept, ask a loan officer for more information.
Before applying for additional working capital, you should be as knowledgeable as possible. Keep reading to learn more!
Annual Percentage Rate (APR) refers to the interest rate of a loan or line of credit, including the total cost of annual and monthly fees. Many business owners confuse a loan’s APR for the interest rate because although these two terms are linked, they aren’t interchangeable.
The interest rate is almost always lower than the APR. Small business financing with a 10% interest rate doesn’t take into account any of the following fees: application, origination, monthly administrative, annual or SBA guaranty.
Small business loans usually have more fees than individual consumer loans, so the gap between the interest rate and APR is much greater. When looking at different financing options, APR is a good way to see which choice will be less expensive in the long run.
A term loan is the most common type of small business financing . Term loans have a set payoff date and loan amount. In addition, they may have a fixed or variable interest rate.
There are long-term and short-term small business loans. A short-term loan has a term of one-year or less, while a long-term loan may last closer to 10 years. Some loans may even offer 20-year terms. Businesses can choose their term when they apply for a loan.
Term loans with fixed interest rates will have the same monthly payment, while variable-rate term loans will have a different monthly payment when the interest rate changes. Businesses can also take out term loans with balloon payments, where initial payments are low with a much bigger payment at the end.
Short-term loans will have higher monthly payments, but lower interest rates as well. This is a great option for a company looking to pay as little interest as possible, but firms with cash-flow problems might be better off opting for long-term loans to minimize monthly payments.
Applying for a term loan is often very rigorous compared to other financing options. Most lenders require collateral to back the loan, and businesses will need a good credit score. To find out your scores, we suggest requesting an updated credit report.
Traditional banks, credit unions, and online lenders all provide business term loans.
Line of Credit:
A business line of credit is when a lender provides access to a certain amount of money that the business can draw from. The business has to repay the amount borrowed in installments. Unlike a loan with a fixed term, a line of credit has no end date.
As long as the business makes payments on time, the line of credit will remain open and available. This is a popular alternative from a traditional small business loan, because there’s more flexibility.
A line of credit is even harder to qualify for than a small business loan. Most businesses need to have a minimum revenue of $25,000 and be in business for a certain amount of time. The amount available in a line of credit also tends to be lower than a traditional business loan.
The total line of credit remains fixed while it’s open.
Factoring is a financing option for companies that prefer not to take out loans or lines of credit. It involves selling a customer invoice to a third-party instead of waiting the typical 30 to 60 days for the customer to pay.
The company typically receives between 70 to 90% immediately from the third-party. Once the customer pays, the third-party will send the remaining amount to the company, minus a fee between 1 to 5% on average.
Factoring lets companies receive money immediately instead of waiting for their customers to pay. This can allow firms with cash flow issues to stay afloat without needing a small business loan or line of credit.
One downside to factoring is that companies don’t receive 100% of what they invoice for. This can be a major problem for companies with narrow profit margins.
Merchant Cash Advance:
For companies that have trouble qualifying for small business loans, merchant cash advances (MCA) can be a valuable gateway to quick cash.
If a company is approved for an MCA, they’ll usually receive the funds within 72 hours. Then, instead of making regular fixed payments like a traditional loan, the lender will receive a portion of the company’s credit or debit card transactions until they fulfill their obligation.
MCAs can actually be easier for businesses to qualify for than a standard term loan, because remittance will depend on future credit card sales. Businesses will remain current on their repayment even during slow months, because it varies based on total transactions.
An MCA doesn’t require collateral to get approved. There are also few restrictions on how the money can be used, and often none at all. If a business experiences a flush month, they’ll be able to speed up the remittance process.
Standard Industrial Classification codes are four-digit numbers that describe the type of industry a small business is in.
The first two digits reflect the major category of business. There are 10 primary groups which include:
- Agriculture, Forestry and Fishing
- Transportation, Communications, Electric, Gas, And Sanitary Services
- Wholesale Trade
- Retail Trade
- Finance, Insurance and Real Estate
- Public Administration
SIC codes are often confused with North American Industrial Classification System (NAICS) codes, which are six-digit codes with essentially the same purpose. NAICS codes became the primary designation for businesses in the late 90s because they’re more descriptive than SIC codes. Even though SIC codes are still used, most agencies and government groups rely on NAICS codes.
The government used to be responsible for assigning SIC codes, but now companies can pick their own SIC codes. Many different agencies still use SIC codes, including the Securities and Exchange Commission.
Staying Up To Date on Small Business Definitions:
Part of being a small business owner is understanding trends and vocabulary related to your industry. If you use outdated terminology or fail to grasp the most current language being used to communicate with your clients and customers, your whole brand will suffer.
This holds true for understanding the language behind small business financing as well. The better grasp you have on the terms used to describe financing products, the better equipped you’ll be to understand your options and communicate your needs to lenders.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.