Are short term business loans the best solution for getting through a cash flow crisis?
This article is about short term business loans and how small businesses use short term credit to fund short term cash flow problems.
There are many ways to obtain a short term business loan. However, passing the credit checking process or having security to support the loan, is where the problems begin. If your small business has a bad credit rating, this will prove to be challenging.
However, in the alternatives to short term business loans, if your small business has bad credit, or if you personally have bad credit, there is an answer to your problem. Also, if you don’t have the necessary security to support the lending required, there is another solution to your lending problem.
Borrowing from banks is not always the best solution for bridging cash flow gaps – Increasing profits is an alternative…and works
Most short-term business loans are for bridging a cash flow gap. All businesses have periods of good cash flow and periods of not so good or bad cash flow.
This article takes a look at this common problem, which is faced by most small business owners across the UK and worldwide.
What are the advantages of short term business loans?
There are many advantages of short term business loans, which include the following:
Small businesses often have cash flow ups and cash flow downs. However, it’s the cash flow downs that are the problem for small businesses.
The reasons for gaps in working capital are numerous. These can be as a result of a large late-paying customer or through a customer that has gone into liquidation. But cash flow blips can also be as a result of seasonal variations in trade too.
It is therefore necessary for small businesses to be able to plug these short-term cash flow gaps. Which is why having access to flexible short-term finance is key.
Flexible short term finance plugs the gaps in small business working capital requirements
A small business does not want to pay bank fees or interest over the long term, when in fact the loan is only needed for a relatively short period.
The best short term business loans and the most popular are bank overdraft facilities. This is because these are extremely flexible and the small business only pays interest when the overdraft is being utilised.
However, in the UK, overdrafts have become much more difficult to arrange since 2008.
Speed of lending
It is possible to obtain short-term finance faster than it is to arrange for long term debt. However, this is only really applicable where the borrowing requirement is small.
Having said that, banks don’t make it easy for small businesses to borrow. I often encounter small businesses that are faced with banks not wanting to lend due to a lack of security or poor credit.
What are the disadvantages of short term business loans?
As with anything which has advantages, there are also disadvantages of short term business loans too. The following are the disadvantages of short term business loans:
Short term loans for small business tend to be more expensive
Short term loans for small business are more expense than long term borrowing.
The interest rates for short term business loans are normally a few points higher. Also, due to the fact that short term lending tends not to be secured, this makes it more expensive too.
The interest rates that banks charge on short term unsecured loans is always higher than on long-term secured borrowing. The reason for this tends to relate to the cost for convenience and for flexibility. Banks are much better able to secure better interest rates over a longer period, as this is the way the markets work.
Withdrawal of lending at short notice
Banks are very good at withdrawing their lending at short notice. It’s usually at a time when the business really needs the support too. The old saying about how banks provide an umbrella when the sun is shining and take it away when it rains, still holds true.
Banks provide an umbrella when the sun is shining and take it away when it rains!
I recently came across this very same scenario. In this case the business had been struggling for a while and needed the banks help and support. However, the bank was not interested.
In this instance the bank concerned was Barclays, and despite top level discussions and trying to renegotiate the lending, the bank was not interested in helping this small business.
If the cash flow blip turns into a long term cash flow short-fall
There is always the chance that a short term cash flow short fall could turn into a longer term problem.
Where a short term business loan has been secured for a short-term working capital need, but the problem extends to beyond the loan period, this could create an even bigger problem.
Banks are usually not keen on second round advances, or re-negotiating loan terms.
Personal guarantees are a risk
Many times short term business loans require a personal guarantee by the business owner(s) or from the directors of the business.
A personal guarantee is where the lending is guaranteed by the business owner or director, so that should the borrowing not be paid for by the business, the lender can seek repayment from the guarantor.
Entrepreneurs sometimes lose their home where personal guarantees are called-in by the bank due to a failure by the business to repay its bank loans
If the business fails, as they often do, the small business owner or director of the business could lose personal possessions. In the worst-case scenario where a personal guarantee is called in by the bank, the entrepreneur could lose their home.
Types of short term business loans
There are a few types of short term lending that small businesses have access to, which include the following:
An overdraft is probably one of the most common and well used types of short term business loans.
However, in recent times overdrafts have been more difficult to come by.
Banks have been reducing their exposure to bank overdrafts since the 2008 banking crisis. But where a small business can arrange an overdraft, despite the banking trend away from these facilities, they are ideal for short term working capital funding.
The main benefit of an overdraft is that the small business only pays for the borrowing when the facility is being used. The overdraft can be ‘dipped’ into as an when the cash flow requires additional funding.
Business credit cards, or even personal credit cards used for business are an easy short term lending solution. However, these tend to be very short term business loans, as the lending is for not much more that 30 days at a time.
On the whole credit cards are fairly easy to obtain. Many banks will give credit on a card and in some cases these can be used to fund a bank balance.
Alternatively, a business credit card can be used to delay payment of the business cost to the following month. Thereby providing a short term business loan. All be it for a month.
Short term business bridge loans
Short term business bridge loans or bridging loans are another alternative. However bridging finance tends to be very expensive. Many times bridge-loan interest is upwards of 1% per month.
However, if you have no alternative, then a bridge loan may be the solution. But, even bridging finance often requires security of lending, or at least a personal guarantee.
What are the short term loan alternatives?
There are a few short term loan alternatives to alleviate short term cash flow short-falls, which can include obtaining a short term loan from friends and family. However, this is not always available. Plus it can put pressure or strain on friendships and families. This is especially true where the business fails and the loan remains unpaid.
However, trade credit can provide for an extremely useful line of credit for any business, both large and small. Trade credit is where the suppliers of goods and/or services allow time to pay after the goods or services have been delivered.
The main advantage of trade credit above all is that it is free. Whereas a bank loans, overdrafts and credit cards have charges and interest applied.
However, this does require negotiation and not all suppliers are happy to provide trade credit.
Increasing sales and profits to ‘trade-out’ of the short term cash flow short-fall
Another alternative to using expensive bank loans or overdrafts for short term business finance is to increase sales and profits.
Sometimes it’s worth stepping back and reviewing a situation with different eyes.
Instead of seeking out bank lending to bridge a gap for a short-fall in working capital, it’s worth reviewing a few key profit metrics instead.
For example, consider reviewing your average transaction value. It’s amazing the impact that a small increase in the average transaction value can have on a small business’s profits.
Small business loan for bakery
For example, a bakery business was in the middle of preparing cash flow forecasts and business plans for their bank for a small business loan.
However, the bakery business plan for a bank loan was put on hold, whilst the business considered an alternative.
The alternative for this bakery business involved two of their key performance indicators. One of which was their average transaction value.
The bakery business owner decided to invest time with his accountant, who happened to have Increase Profit Software. They discovered something very interesting. This discovery resulted in the bakery business not requiring a loan at all.
The cash flow short fall never materialised. This was as a result of an increase in sales and profits after implementing a few carefully thought through ideas. These ideas came from a brainstorming that had been inspired from the output of information shown by Increase Profit Software.
The software had demonstrated that with a few small tweaks to the bakery’s average transaction value and the number of times customers return to the store, that their profits would increase enough to cover the short-fall that was to be covered by the loan.
A small business is more valuable with higher profits and no lending on the balance sheet
Additional advantages of the alternatives to short term business loans for small businesses
There are many advantages for using the alternatives to short term business loans. In fact these advantages outweigh any of the few advantages of short term finance list above in this article.
The advantages include the following:
Saving of interest and lending costs on short term business loans
Even where the interest rate for the short term loan is low, this will always work out more expensive than a situation where no loan is required at all.
In the example of the business loan for a bakery above, the bakery business was looking to borrow around £60,000. Even if the loan was only taken over a 12 month period, and assuming the interest rate was 5% for the 12 months, this still represents a total interest charge of £1,637.
The £1,637 doesn’t take account of the lending fees, which for business loans tend to be around 1.5 to 2% of the loan. for a loan of £60,000 this represents a further cost of at least £900.
If this were your bakery business, or another type business for that matter, then the cost of Increase Profit Software, is minimal compared to the bank lending costs.
No need for a credit check
Business short term loans and no credit checks will never happen. Whereas if the short-term lending option is no longer required, a credit check will not be needed.
The age of your business and the state of your balance sheet will affect the level of borrowing and the terms of any loans. But all lending through the banking route will require a credit check.
Bad credit is no longer a problem
Short term business loans and bad credit don’t go hand-in-hand. For that matter, any lending will prove challenging if you or your business has bad credit.
However, if you are no longer seeking finance, the bad credit history goes out of the window. By focusing on the business and increasing profits instead, means that you don’t need to worry about your bad credit rating.
No security for lending
Unsecured loans are difficult to find, not impossible, but they are certainly not forthcoming from the high street banks on the whole.
However, this problem is swept aside once more where lending is no longer the solution to your cash flow short-fall.
Risk of personal guarantees is taken away
As already discussed in this article, personal guarantees are a risk to business owners and company directors. Where a personal guarantee is given and the business fails, there’s the possibility of losing possessions, or worst still your home.
However, if a short-term loan is no longer an option, then this problem also goes away too. As a business owner, you’ll be able to sleep more easily at night knowing that should the business fail, you will not lose your home.
Long term advantage to the business
The advantages to your business in the long term are many times greater than if you take out a short term business loan.
The focus is taken away from an outside solution and a short term fix. Instead the focus is put on growing the business. The drive is on increasing sales and profits instead.
At the end of the process, the business will be more profitable and more valuable too. Also, once you begin to focus on the key profit drivers of your business, there’s no need for this process to end. The profits will continue to increase and the business will continue to grow.
Low cost of of implementation
The cost of implementing changes that result from using Increase Profit Software are often very low. The return you can obtain from focusing on KPI’s, like your average transaction value, can be huge.
Increased business value
A business with higher profits is a more valuable business. Also, a business without borrowing is more valuable than a business with borrowing.
Therefore, if you focus on increasing your business sales and profits instead of looking for a short term business loan, your benefit is two-fold. This means you have a more profitable business without borrowing.
Finally please comment or social share
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Also, if you are reading this article because you are looking for short term finance for your business, I recommend you take a look at our Increase Profit Software solution. From a minimal investment, you will have a much more valuable and more stable business.