Is a Short-Term Loan ever a Good Idea for your Business?

Short-term loans have become an increasingly popular form of credit both for private individuals and increasingly, for businesses. But while we’ve all heard of short-term lenders like Wonga, the similar lenders in the business world have not received anything like the same level of coverage in the press. But are short-term business loans an effective way to push your business in the right direction, or are they a one-way route to debt distress?

What is a short-term loan?

A commercial short-term loan is generally a very versatile product that offers faster time-to-funding than other loan types for a smaller amount of money over a shorter term. While longer-term loans may include restrictions on their usage, such as the purchase property or equipment, short-term loans tend to be free from restrictions. Typically, they will be used to cover short-term expenses, take advantage of unexpected business opportunities or bridge a gap in cash-flow.   

In exchange for this level of speed and flexibility, short-term loans are usually paid back in instalments and at a high rate of interest.

What are the potential pitfalls of short-term loans?

There are two major factors to consider when taking out a short-term business loan – the cost and the payment schedule. Compared to longer-term borrowing, short-term loans are expensive. As well as interest, you may have to pay an arrangement fee and there may be other costs you need to be aware of.

In terms of the APR, you could easily find you have to pay double the rate of a medium-term loan or 10 times as much as a long-term loan. However, these are not comparable products. If you’re looking for fast cash then you should consider the APRs associated with credit cards and overdrafts as an alternative.  

Another consideration is the payment schedule you have to stick to. It is not unusual to have to repay the loan in daily instalments, which can put a real strain on your cash-flow, particularly if your business receives sporadic payments. This may also reduce the flexibility of the loan and affect what it can be used for. Here are some more pitfalls you should seriously consider.   

When might a short-term loan make sense?

Despite the potential pitfalls of a short-term loan, there are occasions when it could make a lot of sense for your business. However, you should always consider the costs and the benefits carefully and have a specific use for the loan in mind. Potential uses include:

●  To boost cash-flow – If you want to take advantage of early payment discounts offered by suppliers or capitalise on business opportunities that have come your way, a short-term loan can provide the capital you need. 

●  To generate revenue – If you receive a big order you cannot afford to fulfil, a short-term loan could provide the capital you need to buy the raw materials. In this case, you should always ensure the return on investment outweighs the cost of the interest payments and that the customer will pay you before the repayment is due.

●  To firefight – If you’re faced with an emergency, such as a vital piece of equipment breaks down or a vehicle or inventory is damaged, a short-term loan could help you ride out the storm. However, you should always be sure you can repay the loan in full before you apply.

Have you ever used a short-term business loan? What was the impact on your business? Please share your experiences in the comments below.