Short term finance is a useful facility available to businesses in a variety of forms. But how can short term financing help a business? Are there risks associated with it? Here’s our guide to short term finance.
Short term finance is a loan or other credit facility which can provide capital quickly and (ideally) be paid off in a short period of time too, generally within 12 months. They have short application processes, don’t take long to approve, and the money will arrive quickly.
Why would a business need short term finance?
A business might make use of short-term finance to take advantage of an opportunity that may pass them by, otherwise to cover unexpected costs, or to resolve a cash flow issue. These funds can be used for any purpose including purchasing supplies or inventory, making upgrades to infrastructure or anything else.
It is not uncommon for a business to require short term finance, especially businesses just starting out who need capital for initial infrastructural investment, such as machines to produce their products or to acquire the likes of office, factory or warehouse space from which to do business.
What are the potential risks of using short term finance?
The main downside of short-term finance is that interest rates are often higher than long term loans and come with stricter repayment policies too. If a payment is missed, then interest can quickly spiral and this can negatively affect a business’s credit score and financial health, making it more difficult to acquire new financing in the future.
Being unable to pay can create a cycle of debt where new loans are being taken out to pay for old ones, with a small business being particularly at risk. It’s important to have a plan for how to repay back the loan when taking out a loan with higher interest rates. The reason for the loan and return on investment for whatever the loan is being used for needs to be clear from the outset.
What should a business think about before getting short term finance?
It’s important to remain vigilant and do appropriate research before acquiring any type of credit, but especially short-term finance. Establishing how much money will be needed as accurately as possible, how long the loan will be for, what the interest rate is and what the repayment period and terms are will give a business the information they need to establish whether they can afford the repayments and identify risk factors.
General credit best practice will also go a long way: don’t borrow more than is needed, make payments on time, know when to refinance and read the fine print.
Types of short-term business finance
There are a few types of short-term financing for businesses:
- Short-term loans, which are loans paid back over short terms (less than 12 months).
- Line of credit, which works similarly to a credit card in that it allows borrowing up to a certain limit.
- Invoice financing, which allows borrowing against outstanding invoices. Interest rates for these facilities are particularly high but provide cash very quickly.
- Merchant cash advances are based on future sales.
Find out more about short term business finance and other methods of financing here.
