Short-Term Business Loans for Cash Flow Gaps

Business Growth
October 17, 2022

Small and Medium Enterprises (SMEs) encounter cyclical cash flow gaps from time to time. When this happens, business owners will have to confront the choice of taking out a business loan. There are a variety of reasons that could lead to this point: 

  • Imbalanced accounts receivables and payables – Your receivables are not lining up with the deadline period you have to pay off suppliers. This cash flow gap that can be solved by short-term loans.
  • Unforeseen negative cash flow spike – You may have expanded too soon and can’t pay off your employees’ salaries. A Short-term loan can help bridge that gap.
  • Cyclical operational costs – Busy seasons like Christmas or other holidays may prompt you to hire extra help or order more supplies and equipment to fulfill orders. A short-term loan can fix that problem for you.
  • Emergency repairs – Expect the unthinkable to happen. One of your machines may have jammed or your wifi connection is down, but don’t have enough cash lying around to tide you through these. 

When SMEs encounter these cash flow gaps, the norm would still be to bootstrap, call a friend, or go to the bank. Of course, the fact remains that the most common types of financial institutions many business owners are exposed to are microlenders and banks. Informal lenders like microlenders usually have very outrageous rates. It’s at a time like this when it would be optimal to give short-term business loans a look, especially short-term online loans.

What are Short-term Business Loans?

To keep things simple, short-term business loans are expected to be paid within less than 12 months and the interest is normally priced on top of the principal amount. Short-term business loans are usually to fulfill operating expenses needs or used as additional working capital to boost resources for specific projects taking place at a certain time. This would be the general overview on the term but what are the actual specific examples of short-term business loans.

Right now, there are a handful of short-term business loans you can come across. Let’s focus on four in particular:

1. Line of credit. Similar principles to that of a regular credit card, a line of credit acts as easy access to capital for businesses that they can utilize at their own convenience. The whole idea is that once you have been able to repay what you took out from your line of credit it resets back to zero for you to utilize again. It’s appealing due to the ease of access and convenience. However, such benefits come at high costs as described in our “Cost-benefit analysis” below.

2. Invoice Financing. This type of financing has been making its rounds in the SME world. Normally, when you engage in B2B transactions, you will have to give out payment terms that are not necessarily the best for your operational efficiency to win over a buyer. Usually terms of this nature would range from as short as 15 days up to 120 days. Invoice financing serves as a means to bridge the gap and get you the funds before the collection date arrives, this would act as a means to give additional revolving capital immediately instead of having to wait. Once the collections cycle arrives, the invoice that you wanted to advance can be paid back in full after your client pays you back. The whole appeal of this is the minimal risk it entails due to the fact that these are transactions you have already secured and you would also have the means to pay back any invoice you would like to advance in the event that you would need additional working capital right away. 

Learn more about First Circle’s Invoice Financing here.

3. Online Personal Loan. The third may just be the most common and sought out loan by most individuals. With the advent of the internet and ease of access to the masses, applying for an online personal loan is straightforward and easy. Normally, this is what a random individual, or a regular employee would look for. Personal loans are as you would read it which is for personal transactions or obligations the individual would need to pay off. 

Note that there are two kinds of online personal loans:

  • Collateral - these are online loans that require the one applying for a loan to provide property or assets in the form of securities.
  • Non-collateral - these are loans that do not require collateral. 

4. Purchase Order Financing. Lastly, we have PO financing, as it is more commonly referred to. It is for people who tend to bite off a bit more than they can chew and would need additional funds to fulfill a project they have agreed upon. Usually, the projects entrepreneurs accept would not coincide with terms that they have with their suppliers and this could lead to some complications on how to properly fulfill the projects they would accept. It’s not a bad thing to accept projects bigger than your capabilities because that is what you want to do. The only thing that an SME owner should have on their mind however, is how they will fulfill the respective project. The work around to this is to be able to get the project or PO financed. The way it usually works is you can have a certain percentage of the PO financed so you can pay all the necessary overhead expenses that would come with it. The value proposition of this would allow you to say yes more than no to projects that you would be receiving.

To learn more about PO financing and other types of working capital financing that will solve typical cash flow gaps click here. 

Cost-benefit analysis

If you’ve tried pulling out funds from various sources when left to deal with short-term cash flow gaps and have been left to take up valuable time reorganising and balancing your balance sheets, why not try getting a short-term loan. This can be a gap-stop to much-needed expenses without affecting your day-to-day accounts payable. If you know that you would be able to recover the loan quickly, it’s simply the best solution. 

It only becomes a bad decision to take out a short-term loan for instances such as:

  • Using short-term business loans for long-term expenses such as expensive machines
  • Covering risky business deals or purchases. Short-term business loans usually charge higher interest rates compared to long-term loans, because they are designed to be repaid faster as well.

For those who are extra careful and want to make the best out of their loans, here are quick tips:

  • Create a fund or a “piggy bank” if you will, that reminds you to set aside cash on a regular basis so you can repay your loans at the right time. 
  • Do your research well in selecting the best short-term financing that is suitable for your specific cash flow gap.
  • Additionally, do research on the financing firms you have shortlisted to get the best value and ensure loan integrity. 
  • Bonus efficiency tip- liquidate your inventory by looking for buyers online

It’s also a good practice to manage your cash flow better to avoid taking out too many short-term business loans or taking out loans in general too frequently. Here’s a full guide on managing your cash flow better.

Real-life SME Experiences

Based on conversations we’ve had with clients, interest rates from informal lenders can range from five percent per week, 20 percent per month or even 30-40 percent sometimes, which is just not feasible if you’re looking to run a business. Or, they would automatically try to seek financing from a bank. Normally, that would make sense but traditional banks still take time and have too many restrictions. 

On that note, legacy banks are not exactly the friendliest and most welcoming to young business owners. Not taking into account the already rigorous requirements needed to apply for a loan, a good number of people are not aware of what having a “good credit score/history” is and if you do not have any this would typically be used against you because the logic they would have is, “Why would we loan to someone we have no data on especially his/her payment behavior?” Basically, it is an uphill battle because it exposes banks.

This sometimes leaves you at an impasse on what to do because right from the start, microlenders and banking loans are not exactly the best fit for your SME needs right now. This is where you have to think of the situation differently, instead of settling for informal lenders and 12-month loan plans, why not give short term business financing a try?

This is why short term financing is a very underrated solution to a lot of big problems business owners are facing. Especially in uncertain times like these when the economy is down  due to the lockdown and the COVID-19 pandemic. 

Interestingly, you’ll have varying responses by business owners regarding the situation. You’ll have people who want to protect their employees and keep their people at work; you’ll have people who see this is a very big opportunity for their operations and will want to swing the pendulum of power in their way; or you could have a lot on the line and you do not want to lose these new opportunities that you just received. All of which can be solved through an easy and precise short-term business loan.

First Circle is a private FinTech company that enables businesses to achieve their full potential by providing fast, fair, and flexible financial partnership. Click here to apply for financing.

Need business financing today? Apply for one with First Circle by clicking here.

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