Getting over a Cash-Flow Hump: Which is better – a Loan or a Line?

Unless your business has piles of cash available there will—at some point—probably be a need for a short-term or long-term cash infusion to get through.

Before approaching a lender for either a loan or a line of credit, first and foremost, your company house must be in order. To successfully approach any financial institution for a cash infusion, your financials should be clean and show your company’s financial strength and history.

Be ready to bring a current and accurate balance sheet and P&L statement. It will also help to locate an advocate at your bank or lender by leveraging your account relationships, or ask for recommendations from colleagues.

There may even be a lender in your area who is particularly versed in the complexities of the remodeling industry. It will pay off, in the end, to do your homework on the right lender and to approach that lender with a complete package of information about your successful company.

So you have your financials, you have an appointment to talk to the lender. Now what?

First of all, understand the difference in the two main forms of business financing: A business line of credit and a Term Loan.

 Term Loan

 With a business term loan, you borrow a lump sum of money, get it all at once and pay it back over a specific time period (or “term”)—it can range from a year to 20 years. Unlike lines of credit that are typically renewed every 1 – 2 years, a term loan is fixed for the specified amortization period. Lenders prefer loans to be collateralized, but there are options for unsecured terms notes.

You can select term loans with different repayment periods and with fixed or variable interest rates. However, you must begin repaying the loan immediately (even if you don’t use the money right away). Closing costs and interest rates for term loans are typically higher than those on a business line of credit. And, unlike a revolving line of credit, once you use up all the loan funds, you’ll need to reapply for a new loan.

Business Line of Credit

A business line of credit is similar to personal lines of credit, such as credit cards or home equity lines of credit. You have access to a specific amount of financing—say, $50,000—but you don’t make payments or incur any interest until you tap into the funds.

Lines of credit are often referred to as “revolving,” which means you can tap into them again and again. For instance, if you have a $50,000 line of credit and take out $25,000, you still have access to the remaining $25,000. If you pay that $25,000 back down to $0, you still have access to the entire $50,000 without reapplying.

A line of credit typically has a lower interest rate and closing costs than a loan of comparable size. However, if you’re late with a payment or go over your borrowing limit, your interest rate may increase substantially—unlike a term loan, where the interest rate stays the same for the life of the loan.

When to choose a LOAN?

Think of a business LOAN a little bit like a mortgage loan:

  • One-time loan meant for a specific purpose. You will be asked to show exactly what you plan to use the money for and how that will help your business increase sales and profits.
  • A fixed monthly payment is standard with a loan.
  • There will be closing costs.
  • A loan will have a fixed term or amortization period.
  • Loans are best used for long-term investments like buying capital equipment — not cash flow.
  • A business loan will carry a higher interest rate than a line of credit.

A business loan is better when you need to make a large, one-time capital investment that will increase the value of your company over time.

When to choose a LINE?

This kind of cash infusion is meant to help finance ongoing operating expenses. Think of a line of credit as an insurance policy providing a cushion of cash when you need it. That’s why it’s important to apply for a line of credit before you need it!

  • A secure line of credit may require collateral.
  • Borrowers with lower credit ratings will pay a higher interest rate.
  • A business owner may be asked to sign a personal guarantee.
  • If you carry a large balance or make only minimum monthly payments, you can end up paying a lot of interest.

Of course, the drawbacks are balanced by the many benefits:

  • You use the line as needed.
  • You only pay interest on the amount borrowed; quick payoffs can result in virtually zero interest paid.
  • The available credit remains in place for the next time you need short-term access to cash.

Remember, use your lenders to help you grow your company. Lenders are in business to supply you with the capital you need to work and be successful. They are eager to help but will always expect that you understand their requirements. After all, they are in business themselves, and as long as responsible lenders and borrowers can continue to rely on each other, commerce will speed along, and capital will continue to flow.