Short-Term Business Loans: Are They Right for Your Company?
For example, if you had attracted investors but they will only provide you with cash after two years, you might need a loan to bridge the gap. If this were the case, you may want to take out a business loan that matures in two years, when you’re expecting a large influx of cash.
In this instance, having a loan will give you the funds you need until your investors’ money is available. In the event your loan wasn’t due for another year after your investor’s money kicked in, you could be paying interest on money you don’t need.
This example is simple, but it illustrates the importance of choosing the right loan term. However, you’ll need to evaluate more than just timing to determine if a short-term business loan is right for you.
To help you decide, we’ll review everything else you need to know about determining whether a short-term business loan is right for your company.
Short-Term Business Loan Definition:
Essentially, short-term business loans are intended to be repaid over a short period of time. Typically, a short-term is considered a year or less. In some cases, the loan repayment term may be as long as 18 months, but if the term is longer than that, it will be considered a medium or long-term loan.
Often, short-term small business loans are meant for new business owners, or small businesses that have a short-term financing need. If you require a larger loan amount, it may make sense to repay the loan over a longer period of time.
3 Ways to Determine if You Should Apply for a Short-Term Business Loan
1. Consider How Much Money Your Business Needs
Generally, with short-term loans, the balance will be smaller than on longer-term loans because there’s less time in which the borrower can pay the loan back.
Therefore, since there’s less time, the loan payments are higher. To counteract this and make short-term loans more practical, business lenders will generally offer short-term loans of smaller amounts.
Even the most well-timed loan won’t benefit your business if it doesn’t provide the funds you need to grow your business. That’s why it’s important to have a number (or range of numbers) clear in your mind when you decide on a loan option.
2. Decide What You’ll Use the Funds For
Your lender will likely ask you what you plan to use the funds for, but it’s also important for you to know the answer to this question for yourself. Depending on what you need the funds for, you may require a different loan amount or term.
For example, if you were using a short-term loan to fund an expense that may or may not go away in the next six months, you might want to find a loan that has favorable prepayment terms. That way, if you have the funds to pay your loan off early—and you’d like to do so—you can do it without incurring extra expenses.
3. Determine Your Business’s Sales Revenue
You should consider all of your current financials when deciding on a business loan, but your sales can be of particular importance. Lenders will evaluate the health of your business partly based on the sales you generate. If you have low sales numbers, they’ll see you as a riskier borrower and charge interest or fees to compensate for that risk.
With a short-term loan, this could potentially make the loan much less attractive to you as a borrower. In that case, it may make sense to wait until sales tick up or pursue a long-term loan in search of a more favorable deal. You should also consider the cyclical nature of your sales, as this could affect your ability to make your payments on time.
Ultimately, you’ll need to decide if a loan makes sense for your business based on whether you can afford to make the monthly payments.
Are You Ready to Pursue a Short-Term Loan?
Regardless of the business loan term you prefer, take time to evaluate the big picture before deciding on a loan of any kind. Consider all the expenses of the loan, how long you’ll be incurring them, and any potential cash flow issues you could face when paying the loan back.
In addition, you should think about what this additional working capital will be used for. The expenses you take on now, in the form of a short-term loan, should be small relative to the return you’ll make using the proceeds of the loan.
When you’ve answered these questions for yourself, determining whether a short-term business loan is right for you should be fairly straightforward.
Editor’s Note: This post was updated for accuracy and comprehensiveness in May 2021.
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.