Your business is successful – so successful, that it’s time to start thinking about expanding. The problem? Business growth can be a double-edged sword. On the one hand, getting bigger – whether by opening a new location, expanding your product line, or just hiring more staff to take on extra work – will help increase revenue. On the other hand, in the short term, expansion can affect the bottom line, and make finances a little tight.
Therefore, once you have made the decision to expand, you need to decide on the best small-business financing option for the expansion while still keeping the business afloat and maintaining a healthy profit margin. Many businesses opt to take out a business loan from the bank, which certainly has some advantages, but for many small companies, securing a line of credit is actually a smarter financial move in both the short and long term.
Loan vs. Line of Credit Explained
Because there are some similarities between loans and lines of credit, some people think of them as being the same thing. However, they are actually quite different.
A loan is a set amount of cash that is repaid in equal installments, usually with interest. In some cases, the lender will also require collateral; if the borrower does not adhere to the terms of the loan, the bank can take possession of that collateral as payment toward the loan balance. Most loans are fixed rate, and borrowers must prove that they can repay the loan in order to qualify. Typically, business loans can only be used for a specific purpose, such as buying equipment.
A line of credit has some similarities to a loan, in that the lender provides cash that must be repaid within a certain period. However, unlike a loan, which provides a lump sum amount all at once and requires regular repayment, a line of credit allows the business to borrow up to a certain amount without having to provide additional collateral or proof of ability to repay. Essentially, a line of credit is similar to a credit card, in that it’s a revolving balance, but generally offers a higher limit and lower rates (which are usually adjustable) than a credit card.
Why a Line of Credit Is Better for Expansion
So what makes a line of credit a better choice for expansion? One of the major reasons that they are more popular for such projects is that term loans are usually paid off over a period of years – and the expenses are for fixed assets, such as a machine that will remain useful long after the loan is repaid. When the expenses are short term, it makes more sense to use a line of credit that will be repaid more quickly.
For example, imagine that your business lands a new customer who places a major order – but part of the deal is that the customer has 60 days to pay rather than your standard 30 day terms. You don’t want to lose the deal, but you also need to outlay some significant cash to fulfill the order. A line of credit can help keep your business operating in the black while you wait for payment, and when the payment comes in, you can repay the line of credit.
A line of credit also has other advantages when you are looking to expand, including:
- Lower fees. Business loans do incur costs, including application, processing, and credit check fees, as well as closing costs. Depending on your bank, you may incur similar fees with a lines of credit, as well as a fee for each transaction, but these fees are often much lower than loan costs.
- Faster access. Applying for a loan takes time – sometimes up to a few months. A line of credit gives you immediate access to funds, as long as you’ve established it before you need it.
- More flexibility. Again, most loans have strict rules about how you can use the funds. A line of credit does not have the same restrictions, meaning that you can use it for operating expenses, payroll, inventory, or anything else that you need.
Both loans and lines of credits are viable options for financing your business. However, if you are looking to expand, and just want to avoid taking a major hit to your profits in the short term, a line of credit is most likely your best bet. Talk with your financial professional to determine the best option for your situation, and grow your business with confidence.