When applying for business funding, one question that many business owners have is; 'what is better a business loan or business line of credit?'
The best answer, although not the simplest, is that it depends on the use of those funds.
Business lines of credit are essentially short-term financing vehicles based on relatively known payback events like the conversion of assets. Business loans are more for long-term financing needs such as the purchase of durable assets.
Most business loans or lines of credit should be matched to the need of the business. Example, a retail home and garden business needs to purchase trees and shrubs now for the up coming spring season where it will sell the bulk of this inventory. There is no sense in applying for a long-term, say a 5 year loan, as the business will have to again make new purchases next spring.
A short-term seasonal business line of credit would be much better for this business. As the business begins to sell its inventory during the spring and summer seasons, the business will generate the cash flow to repay the advance against the line of credit - thus matching the sale of those assets to the cash flow or advance from the line of credit. Not only will this be cheaper in fees and interest for the business, but, the business will essentially use the assets purchased from the advance to pay for themselves as well as provide a profit for the business; to be used for cover other overhead or growth needs like salaries and marketing.
Also, as stated, matching the loan product to needs can save your business money. Think about this. A short-term $100,000 business line of credit for 12 months at 8% interest will cost the borrower $4,400 in interest. The same amount at the same rate for a 5 year business loan will cost the business some $21,700 in interest.
Business lines of credit are essentially large credit cards. Your business can draw upon the line, pay some or all of it back, then draw again if needed. The main difference is that most business lines of credit are secured by some type of short-term assets (like described above with the retail home and garden business); assets that can quickly be converted into cash. Another difference is that you might have a credit card for life, but most business lines of credit have terms of one year (12 months) or less.
Most banking policies require that all lines of credit be paid to zero (paid in full) sometime in a 12 month period. This not only reduces the risk to the lender - not having an outstanding loan for long-periods of time - but also allows the lender to re-evaluate your business before approving or renewing your business line of credit.
Therefore, when seeking funding for your business, to save yourself both time and effort, you should first have a good understand of your needs as well as the use of banking or lending products. Finding the right financing vehicle for your business will not only meet your immediate capital needs but will save your business tons of cash in the long-run.