Businesses usually face a shortage of funds at some point in their life cycles and many of them resort to traditional financing methods such as short term or long term loans. It is important to understand the purpose of the fund requirement and your ability to repay the loan in order to make a selection between the two options. Along with this, understanding the circumstances favourable for such loans will help you make a wise decision. Let’s start by quickly understanding the two loans.
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Short term loan
This loan is typically required to be repaid within one year from the date of taking the loan. Certain institutions also provide medium term loans that must be repaid within 3 years. Some of these loans are unsecured and have higher interest rates while few lenders might ask for collateral while providing the loan. Secured loans usually have a lower interest rates compared to unsecured loans.
You can get a short/medium term loan for your business by clicking here
Long term loan
These are loans that have repayment periods exceeding 3 years and going up to 20 years in some cases. These loans usually have a fixed monthly or quarterly repayment schedule.
Conditions favourable for taking a short term loan
– Seasonal costs
If you have a seasonal business, chances are that you require extra capital to pay your temporary workers or purchase more equipment. Or if your business is going through a low phase, you might require funds to meet operational expenses. In such cases, a short term loan does the job for you if you are sure of the temporary trend and confident about making the repayments later.
– Starting a business
Often, the entire capital investment needed to start a business may not be available immediately but you are confident of your ability to make arrangements for these funds at a later stage of the business cycle. Taking a long term loan would do no justice to your ability to make the repayment in a short period of time. These situations particularly call for a short term loan as you know that you can pay off the loan in the following months.
– Buying inventory
Businesses might require inventories to satisfy the increasing demand and make additional sales. There may be an instance when an inventory might be available at a discounted price but there isn’t sufficient cash to buy it. In such situations, it is advisable to take a short term loan to fulfil the current requirement and make timely repayments later.
– Emergency repairs
Unfortunate events such as sudden machinery breakdowns and computer crashes can stall sales and hamper cash flows. Also, there might not be sufficient liquidity to make the necessary equipment purchases or repairs and get your business on its feet again. In such a situation, it is advisable to take a short term loan if you are facing a temporary liquidity crunch and are confident of being able to repay the amount in a short span of time.
– Working capital
It is preferable to take a short term loan if you are facing a gap between your account receivables and payables and need some funds to pay your creditors. Again, if you know the situation is temporary, a short term loan can help you bridge the gap by paying off your bills.
However, in such a situation it might be preferable to approach a financial institution for bills discounting, a process where the bank or financial institution buys the bill (i.e. Bill of Exchange or Promissory Note) before the payment is due and the value of the bill after a discount charge is credited to the customer. In essence such a practice is akin to an advance against the security of the bill while the discount represents the interest on the advance given.
Overall, make sure that you have considered the principal amount required, the interest rates and your ability to make repayments before applying for a loan.
You can compare business loans offered by banks in UAE by clicking here