Small businesses often face situations where extra capital is needed, whether to cover short-term expenses or finance long-term growth. Two popular financing options are a line of credit (“LOC”) and a term loan, each serving different purposes depending on your business needs. Understanding when to use an LOC versus a term loan can help you make a more informed decision. 

What Is a Line of Credit (LOC)?

An LOC offers flexible, revolving credit that your business can draw from as needed, up to a pre-approved limit. Similar to a credit card, an LOC allows you to borrow, repay, and borrow again. It’s ideal for covering short-term expenses or managing unpredictable cash flow. If you’re facing extended payment terms or need quick capital to cover expenses while waiting for customer payments, an LOC can provide liquidity. For more details, check out our post on cash flow constraints.

When to Use an LOC

  • Managing Cash Flow: Businesses often use an LOC to handle day-to-day expenses like payroll or inventory purchases, especially when cash flow is inconsistent.
  • Short-Term Needs: An LOC is perfect for covering unexpected expenses or handling gaps caused by delayed receivables.
  • Flexibility: You can access funds only when you need them and only pay interest on the amount you use, making it ideal for ongoing expenses.
  • Repayment: You typically pay interest only on the amount you use, not the total limit. Once you repay what you borrowed, you can borrow again.

What Is a Term Loan?

A term loan provides a lump sum of money with a fixed repayment schedule over a set period, often used for major investments or long-term projects. If your business is expanding and you need capital for larger purchases, like equipment or real estate, a term loan could be the best fit. For businesses in a growth phase, a factoring solution can be another effective option.

 

When to Use a Term Loan

  • Long-Term Investments: If you’re purchasing new equipment, expanding operations, or acquiring another business, a term loan provides the upfront capital needed.
  • Predictable Costs: With fixed payments over time, term loans help with budgeting and managing long-term debt repayment.
  • Growth Financing: Term loans are typically used for larger, one-time expenditures that will generate future revenue, making them ideal for expansion.
  • Repayment: You repay both the principal and interest in regular, fixed payments (often monthly).

Which Option Is Right for Your Business?

Choosing between an LOC and a term loan depends on your business needs. If your expenses are short-term and unpredictable, an LOC offers the flexibility to meet those demands. However, for larger, more predictable expenses or growth initiatives, a term loan provides the structure and stability needed for long-term planning.

For businesses looking to manage cash flow or finance growth, both options are valuable, depending on your financial situation and goals. If you’re unsure which option best suits your business, we can provide free consultation to weigh your options effectively.