Some small business owners seem to think that there’s really no difference between working capital lines of credit and business loans they can get from a bank. They’re basically both money that you can get for your business which you have to pay back with interest. But actually, these are two very different forms of financing, and if you’re contemplating on boosting your cash flow you should be aware of some of the key differences so you can make the best choice for your business.
Business loans can be used for a whole variety of purposes. But essentially, all these possible reasons can be categorized in two distinct categories. Either the loan is used to cover operating expenses to keep the business afloat, or they can be used for some sort of growth or expansion for the business.
Working capital lines of credit are usually used to cover regular working expenses, such as overhead and salaries.
Usually, a business loan involves a fixed interest rate. It’s different with the line of credit, as they’re usually tied to a specific variable rate like the prime rate or the Treasury bill rate. This interest rate may range from 1% to 6% over the tied-in rate. This means that every month the interest rate may change for the line of credit.
The interest isn’t the only thing you need to pay for when you take out a loan or a line of credit. Loans may involve a variety of fees, such as the loan processing fee and the credit fee. There may even be a fee if any collateral needs to be appraised. With the line of credit, there may be a processing fee at the start and then an additional transaction fee whenever you draw from the line of credit.
Receiving the credit amount also differs among these two financing options. With a business loan, you get the entire amount of money right at the start when the loan documents are signed. You don’t get any additional money from the loan. But with a line of credit, the loan works very much like a credit card. You have a limit, and then you can borrow as often as you want as long as you don’t exceed the specified limit. If you pay back the amount you’ve used, then you can continue borrowing as often as you need to as long as it doesn’t go over your limit.
With a business loan, some items are specified. You have to pay an exact amount on a regular basis until you pay back the loan and the interest. With the line of credit, the amount you have to pay depends on the agreement you have with the lender. For example, you may only be required to pay the interest due, or you may also have to include partial payment of the principal.
So if you are a small business owner, consider these differences carefully so that you may make the right choice as to which is the right option for your business. For some, loans may be very useful, but for others the availability of working capital lines is the best option.