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Short Term Financing Explained

Updated: Dec 9, 2019

Short Term Financing Explained

Short Term Financing

For many small businesses, it is necessary to secure additional funds to cover expenses, or to take the next step in growing the business. Before determining the best type of loan for the business, however, it is important to clearly outline what kind of need the loan will fulfill. Ascertaining what the money will be used for will help the borrowing business to choose the best way to finance their need. Short term loans are a lending option that work for many businesses that experience seasonal revenue fluctuations, or that otherwise require a small, quick loan to cover expenses that will be repaid in projected revenue in under a year.

Most short-term financing options are tied directly to immediate sales; they are relatively easy to qualify for as long as the business has a positive cash flow or outstanding invoices to use as collateral. Short-term loans are rarely secured with a larger asset. As a consequence, however, they are usually more expensive in terms of fees, interest rates and APR than longer-term loans, and are generally available for smaller amounts than secured loans. Short-term financing is not a recommended option for significant investments in the company – such as renting or purchasing new space – due to shorter payback periods, lower loan amounts and more expensive financing. For businesses that need additional capital for short-term inventory purchases or experience seasonal spikes in revenue, however, short-term loans are a viable option.

Short-term financing options have more frequent payments than longer-term financing –repayments are often taken out of daily sales, or require repayment within 30 to 90 days. In comparison, longer-term loans are usually a fixed amount paid off at regular intervals, such as biweekly or monthly.

There are several short-term financing models to choose from: a business line of credit, merchant cash advances, and accounts receivable financing.

Summary of Short-Term Financing Options

Merchant Cash Advances:
Loan amount: $5,000 to $500,000
Loan term: 1 week to 3 years
Repayment schedule: Daily – lender takes percentage of daily debit and credit card sales until loan is repaid
Factor Rate: 1.1 to 1.5 factor rate

Business Line of Credit:
Loan amount: $2,000 to $3 million (larger loan amounts may require collateral)
Loan term: 6 months to 10+ years
Repayment schedule: Revolving, with minimum payments due monthly
Interest Rate: Prime interest rate plus 1 to 32 percent

Accounts Receivable Financing:
Loan amount: Up to 90 percent of outstanding invoices
Loan term: 30 to 90 days
Repayment schedule: Repayment due upon payment of outstanding invoices
Interest Rate: Percentage of outstanding invoice, plus 2 to 3 percent processing fee

Short-Term Financing Options

Merchant Cash Advances are a viable option for businesses that have steady sales from debit and credit cards, and are often the best opportunity available for business that lack collateral or have too low of a credit score to qualify for a traditional loan. This route provides a cash advance that is paid back via a percentage of the total credit and debit card sales each day until the entire amount – plus fees – has been paid back. Although merchant cash advances are one of the most expensive versions of short-term loans – depending on the daily sales amount, the APR can end up in the triple digits – they do provide the advantage of being directly tied to sales. If the business has a slow month, the amount paid toward the advance will be smaller as well.

Business Lines of Credit work much like a credit card and are a viable option for businesses that need an ongoing source of working capital. They are best for businesses that have been in operation for at least a year, with $60,000 or more in annual revenue. The business is given a certain amount of credit to use, and are required to pay a small part of the balance due each month. Interest is charged on the outstanding balance.

Accounts Receivable Invoicing, also referred to as invoice financing or factoring, allows the business to borrow up to 90 percent of the amount they are owed in outstanding invoices. Invoice financing is usually paid back within 30 to 90 days, and works best for growing businesses with a positive cash flow that require flexible short-term financing. In accounts receivable invoicing, the lender holds 10 to 50 percent of the loan amount in a reserve account. As soon as the invoice is paid, the lender deducts the processing fee and factor fee, after which the remainder is turned over to the business for use. The downside of this short-term loan option is that the factor fee is generally charged on a weekly basis. Therefore, the longer it takes for the customer to pay the invoice, the more costly the loan becomes for the business. Nevertheless, the outstanding invoices act as the collateral for these loans, and obtaining them is relatively quick and easy.

Ultimately there are several options that are available to small businesses looking for short-term solutions for covering expenses. Although these options may be higher interest than longer-term loans, they are ideal solutions for businesses that have short-term gaps in their revenue or require additional funds to increase inventory.

More from the Resource Center: How to Get the Best Small Business Loan

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