Finance 101 - 11.17.2016

3 Reasons to Use Term Loans for Working Capital

Any small business needs a substantial amount of working capital to cover the costs of daily expenses and operations.

While term loans aren't always the first option one thinks of when looking to boost working capital, they have some advantages over a line of credit that you may want to consider.

Why Is It Important to Have a Good Amount of Working Capital?

Before discussing the reasons to use term loans for working capital, first consider why you need to have a good amount on hand at any given time.

Obviously you need working capital to keep the business running, but it is also an important indicator of the financial health of a business. Investors and lenders will calculate working capital into their decisions to invest or provide you with a loan. It also enables you to be better equipped to make decisions regarding near future endeavors and growth.

What Else Can Working Capital Be Used For?

With substantial working capital available to the business, there are many things it can be used for. You can make large inventory purchases, upgrade or purchase new equipment, expand your business, hire new employees, improve employee training and more. Additionally, you will be prepared to handle any unexpected problems that occur, such as equipment failure or damage, vehicle repairs and damage from natural disasters.

Term Loans Versus a Line of Credit

A line of credit is the common option for those who like to have access to more working capital when they don't necessarily have it on hand. A line of credit may also be favorable because instead of taking out a loan for a large lump sum, you only spend what you need. In addition, you are only responsible for paying back what you've spent.

That being said, there are three large reasons why a term loan might actually be a better option:

1. Term loans typically grant you much more than a line of credit

A line of credit has a limit, and once that limit is reached, you may not be able to get anymore. Plus, it may then be more difficult to acquire additional funding from other sources, as your credit score might be suffering. Term loans can provide you with substantially more cash than a line of credit, and though you have to make monthly payments back, you also don't have to worry as much about reaching a low limit.

2. Payback terms are more feasible

A line of credit often has a high APR, whereas a term loan will have a more favorable APR, as well as the possibility of longer term and fixed monthly payments, making it easier to pay the loan back. Knowing how much you have to pay each month gives you a better idea of how much working capital you have on hand each month.

3. A line of credit can be revoked

A lender can decide at any time to revoke a line of credit, for reasons that might have nothing to do with your business. Additionally, terms and APRs can also change, making a once favorable line of credit not such a good option for working capital after all. It is much harder for a lender to pull a term loan than a line of credit.

Take some time to do some additional research before making a decision, so that you fully understand all the terms involved in either selection. Calculate your payments for a term loan, keeping in mind that revenue might change from month to month or season to season, and you'll be able to make an informed decision.


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