In a business, there comes a time when you turn to fundraising. This can be by using your personal savings, by raising funds from investors or, the most common option, by taking out a loan. A loan is a sum of money borrowed, the principal, to be repaid at a predetermined due date, plus interest, which can be at fixed or variable rates. Just a quick browse online and you will see that loans can range from a prepayment period of one year to 10 years. Although not yet obvious, the term of a 1-year loan varies considerably from a 10-year term, depending on www.firstcircle.ph.
Below, you’ll learn all about short- and long-term loans, their pros and cons, and specific situations when one is better than the other.
Short term credit
Short-term credit is a type of business financing in which principal plus interest must be paid within one year; hence the name short-term credit. This is mainly used to finance operating expenses or working capital requirements.
Advantages of short term credit
Faster Application: As this loan has a maximum term of one year, the amount that can be borrowed would be much less than a long-term loan amount. For this reason, the application process is less strict and much faster.
Quick access to capital: Compared to the above, with short-term credit, the process of applying for and releasing funds takes faster than its long-term counterpart. Funding is released immediately, so you can use the money to pay for emergency expenses, whether it’s paying suppliers or your employees.
Fewer restrictions: Not only is the approval time faster, but with short-term credit, the documents you need to submit would be far fewer than if you were applying for a long-term loan. This is because you are not borrowing an incredibly large amount (compared to a long-term loan), which equates to less risk for the lender. As short-term credit carries less risk, the lender will not enact provisions (e.g., salary caps, approval or denial of expenses/professional projects) or closely monitor your business, which could limit the taking of decision.
Disadvantages of short-term credit
Higher costs: As short-term credit provides quick and efficient access to capital, interest rates are higher. However, low interest rates are not always the best option. If you have to fulfill deliveries and orders to generate sales, wouldn’t you take out a short-term loan at high interest rather than not taking out a loan and having no sales because you don’t didn’t have the capital? When making a trading decision, it is important to assess the situation because no two situations are the same.
Can open a cycle of repeated borrowing: Because the application process is quick and you get funding right away, short-term credit is a quick fix that can be too easy if you get used to it, and you can fall into a cycle of repeated borrowings. loan. If you take out a short-term loan this month to pay suppliers and take another one the following month to pay your employees, it’s a sign that your business is not running efficiently. Don’t take out short-term finance on a regular basis because you will become dependent on it, which is bad for your business.
Unsustainable in the long term: As mentioned above, becoming dependent on credit in the short term is bad for business because it is not sustainable in the long term. The goal of any business is profit. If you regularly take out loans because your income is not enough to cover your expenses, you are not making any profit.
When should you get short-term credit?
You need cash quickly: Short-term credit can be considered an emergency fund, provided you have the means to repay the loan. As the application process and wait time is fast, this would be the most efficient way to obtain funding rather than presenting to investors or applying for a longer term loan.
Your borrowing requirement will not exceed one year: you pay your employees fortnightly and buy supplies regularly. If you need the loan to finance a business expense, it won’t last more than a year; then short-term credit (versus long-term) is the best option for you.
You can control your expenses: Opt for short-term credit, if the situation calls for it, if you can control your expenses. As mentioned above, funding is released almost immediately for short-term credit. It’s easy and fast money, and the money that is received with less effort can be spent faster than the money you worked hard to earn. If you can’t control your spending, you risk starting a cycle of repeated and unsustainable borrowing with short-term credit.
Long term loans
Long-term loans are a type of business financing in which the maturity date of the loan extends beyond one year and can even last up to 20 years (eg commercial real estate loans) . It is mainly used to finance long-term projects such as business expansion, franchising, purchase of fixed assets and other fixed assets.
Advantages of long-term loans
Longer Repayment Period: With a longer repayment period, you are not so in a hurry to repay the entire loan amount quickly; However, that doesn’t mean you have to push your monthly payments to the back of your head. As this is a long-term expense, you should always have a plan to tackle debt.
Lower interest rates: Long-term loans generally have lower interest rates than short-term debt. This is because the demand for long-term finance is much stricter because more risk is involved being that more money is also involved; however, as you’ll find out later, you’ll spend more on interest with longer-term loans.
Can fund large expenses: The goal of any business is profit, and with that comes the ability to scale or grow. The more your business grows, the more expenses will increase, and some of them will be costly. If you need to automate the production of your product, you will need to purchase the machines. What if you need multiple machines? This can come with a hefty price tag. Enter long-term loans – these can finance major expenses such as financing a property purchase to call your new office.
Disadvantages of long-term loans
You pay more total interest: Even though interest rates are lower with long-term loans, you still pay more interest because the amount you borrowed is more than the amount that can be provided with financing short term ; however, as previously explained, you must assess the individual situation.
Limit monthly cash flow: This is very much related to one of the benefits of long-term loans – you have a longer repayment period. Although you have more time to pay off the loan, it is still highly advisable to make regular payments, as you don’t want to spend more on interest.
More rigorous application process: Since the amounts of longer-term loans are much higher than the amounts provided by short-term loans, the risks are greater for lenders. To minimize their risk, the application process is rigorous to weed out those who they believe do not have the credit history or ability to repay the loan.
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