Today, running a business is not like a walk in the park anymore, especially with huge competition and recurring costs that keep on flashing at you in the daylight. For starters, you need minimum working capital to meet your day-to-day operational requirements, such as buying inventory, paying daily wages to the labour, and other short-term obligations. But sometimes, due to dire circumstances, your business might not have any money in the pockets to run its operations for the day. Or, maybe they had to pay the debts to a big client, for which they had to sell their fixed assets or go for debt borrowing.
These kinds of situations occur only when your business is short of cash or doesn’t have enough reserves. Now the next thing most businesses do is either trim the employees’ salaries and labour wages or if the situation is even worse, they end up shutting down the business for a temporary period until the dust settles in the air. Conversely, as per the accounting standards, we all know that business is perched on the going concern concept, which means, every year, businesses prepare financial statements with an assumption that they’ll continue operating their business in the future.
Although business is a separate entity, they need a little push to boost their confidence to revive their business and some quick cash to keep their business going. Now, when people or businesses need money, they generally go to a bank asking for a loan or borrow from near and dear ones. If nothing works, there are alternative lenders in the market who are always ready to invest money in the business, but in return for a share of profit, say, pawnshop owners, merchant bankers, and federal credit unions.
The last thing that comes to mind for a customer when it comes to borrowing money is to go for a line of credit because most of them are oblivious of what it is and how it works. And even banks were never seen promoting this product, as most of the businesses approach for short-term commercial loans, and if it’s a substantial company with a huge turnover like Reliance or TATA, they ask for long-term commercial loans by putting down huge collateral with the banks.
So here comes the big question- Should businesses go for a line of credit or a small business loan? To clear the confusion, let’s dive into the specifics of both the products, their offerings, and benefits from a business point of view. In this article, most of your indecisions will come to an end.
Business Line Of Credit Vs. Small Business Loan
A business line of credit, also known as LOC, is a short-term loan borrowed as a fixed amount from the bank, where businesses can meet their regular operational needs like buying raw materials or paying daily miscellaneous charges. In simple words, it’s more like a credit card, where a certain amount of money is allocated to the business at first to use, as and when needed, and repay it after a period. The moment business borrows money, they are charged with interest.
Once the amount is paid, excluding interest, the LOC is reactivated with the designated amount, and again ready to use whenever the business requires quick cash. Moving ahead, the business line of credit is subdivided into two types- Secured business LOC and Unsecured business LOC. When it comes to secured business LOC, businesses have to put down some collateral as a form of guarantee.
Generally, collateral for this form of loan would be securities, inventory, account receivable, and anything that can be easily converted into cash. Whereas, under unsecured business LOC, lenders ask for huge collateral like machinery or something that has high resale value. Plus, as the loan is unsecured, the interest rates are quite high too.
Small business loans, on the other hand, are given to businesses in lump-sum, where they need to repay after a certain period along with interest. These loans are taken for a specific purpose. They are also divided into short-term business loans and long-term business loans. Under short-term business loans, the amount borrowed is utilized to meet the working capital requirements of the company, just like a business line of credit. Whereas, long-term business loans are taken for restructuring the business, buying machinery or any fixed asset, or setting up a new unit.
Choosing Between the Two
From a business viewpoint, both lines of credit and small business loans solve the capital needs at the eleventh hour. But, in line of credit, there’s greater financial flexibility, unlike small business loans. And also, cash is readily available at the doorstep when you are in a haste. The best part of the business line of credit is that, if you don’t use the money, there’s nothing to repay.
In small business loans, there’s a fixed monthly installment that needs to be paid to the bank along with the interest amount. Line of credit would be a valuable financial tool if as a business you are looking for fast cash, otherwise, small loans would solve your money crunch problem.
The author is a freelance journalist and writer
DISCLAIMER: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.