But what’s the difference and which one do you need?
Whether you are just starting a new business, looking to grow in the coming year or are in the midst of a growth spurt already, you might find yourself in need of a business loan or a line of credit.
For many business owners these two terms can be confusing, but you don’t need to fear the business lending process. There are a few key differences between these two business tools, and knowing how to best use each one to improve your bottom line is not as complicated as you might think.
In a nutshell, a business term loan is typically used for an asset purchase, such as a piece of equipment or company vehicle. This purchase is normally one that is reflected on the businesses balance sheet as a depreciable asset. The loan is paid on a fixed monthly basis with both principal and interest going toward the loan amount. The terms of the loan can range from one to seven years, depending on the life of the asset.
Bottom line on a loan: it should always be used for some type of asset, such as equipment or a vehicle. If it’s going to go on your balance sheet, use a loan for it.
A business line of credit is a financial instrument typically used for an organization’s short-term working capital needs, such as inventory purchases, future project costs, or company payroll. Lines of credit are to help even out your cash flow. Terms are usually annual with an interest rate based on the prime rate plus one to three percent. Payments are interest-only on the amount you borrow.
Typically, banks prefer to see that the line has been “rested” or paid down to a zero dollar balance at some point during the year. Lines of credit range from $10,000 to as high as $500,000, depending on your business needs.
To help illustrate the difference, let’s look at one of Telhio’s business members who runs a small marketing firm out of her home office. She typically invoices customers at the end of each month, but might have expenses from vendors that she has incurred on her customers’ behalf that are due before she collects payments from her customers. A line of credit is the perfect solution for her. She can use the line to pay the vendors and once she collects from her customers, she can pay down the line of credit balance.
In comparison, when that same member has grown her business and hires employees, she decides to open a small office and rents an office location. To purchase the office equipment, furniture and other assets, she takes out a small business term loan and pays the loan back as she depreciates the assets on her balance sheet over a five-year period.
It’s important to use each of those two financial tools correctly. Using a credit line to pay for equipment would be like using a credit card to buy a car. However, when a business owner has a credit line, sometimes he or she might need to make a quick equipment purchase and use the line of credit to do so.
Let’s say a piece of equipment breaks down during a tight deadline job and the owner needs to replace it quickly. When this situation has happened at Telhio, we have worked with our business owner members to roll the purchase over into a business term loan, allowing the business owner to free up his or her line of credit for its original purpose.
This brings us to my final piece of advice: when shopping for a financial partner for your loan or line of credit, be sure to find one that will truly be your partner. You should be able to have a candid conversation with your lender about your business, your goals and your vision for the company’s future.
Based on that conversation, your financial institution should be able to provide you with the tools you need, and guide you in a direction that will lead to success for you and your organization in the long term.
Telhio Credit Union is open to everyone who lives, works, worships or attends school within Franklin County and surrounding communities. Founded in 1934, originally as the credit union for the Columbus Telephone Co., Telhio is a not-for-profit financial cooperative where its members are also its owners. Driven by its philosophy that members come first, Telhio is committed to the highest standards of responsibility and conduct.
Telhio offers a variety of innovative programs, services and products to support its members’ financial needs. Telhio offers seven branching offices throughout central Ohio and nearly 4,000 shared branching locations nationwide. Additionally, Telhio participates in the highest level of combined federal and private share savings insurance available, insuring deposit accounts up to $500,000.*
* Federally insured by NCUA. Additional coverage up to $250,000 provided by Excess Share Insurance Corporation, a licensed insurance company.