What entrepreneurs need to know about revolving loans versus term loans
By ATB Financial 23 October 2020 4 min read
Your journey to growing your business is well underway. Now, you might be thinking about how you’re going to fund its success as you grow.
ATB Entrepreneur Strategist Catherine Glambeck says business owners—like you—should be thinking about how to financially support their business in the very early stages of planning. It’s critical to map out the options for financing your business including personal savings, support from friends and family, money from investors and loans from financial institutions.
Whether you need to cover your cash flow for purchasing raw materials, upgrade equipment to ramp up production, or finally sign a lease on that storefront location, if you don’t have a large amount of money squirreled away, it might be time to consider a loan.
But what are the types of loan you can get and what do you need to secure one?
Term loan versus revolving loan: considerations for small businesses
What is a term loan?
This is a loan for a one-time, set amount of money that is paid back with interest over a predetermined period of time (known as a term). Interest rates on term loans can be fixed or variable and the length of term can depend on the product or what’s negotiated with your bank.
“A term loan is good because you can budget it back into your monthly cash flow and you know it will be paid off by a certain time,” says Glambeck.
Term loans are a fit for an entrepreneur looking to buy a new piece of equipment, acquire another business, purchase a building or property, or make building improvements, she says.
Another way to think about it is term loans are typically used for purchasing assets that will not be converted to cash within a year.
What is a revolving loan?
A revolving loan is a set amount of money that an entrepreneur has access to—like a line of credit or a credit card—to spend when they need it and then pay it back plus any interest accrued.
For example, if you have a $10,000 line of credit and need $3,000 for production materials, you will carry that balance and accrue interest while still having access to the remaining $7,000. Once you pay back the $3,000 plus interest, you’ll have access to the full $10,000 again.
“This type of loan is typically used by entrepreneurs for cash flow,” says Glambeck.
For example, you might have to order your product two months before your busy season. You can use funds from your revolving loan to cover the purchase and once sales start, you pay back the loan. Another example is if you’re waiting on a client to pay an outstanding invoice and you have payroll to cover. With a revolving line of credit, you can pay your employees and then make a payment once your client pays their bill.
What do I need to get a loan for my business?
It can be difficult for brand new businesses to get business loans, says Glambeck. If a business doesn’t have at least a year’s worth of revenue, there often isn’t enough financial information for the bank to adequately assess the company’s ability to carry the loan.
For businesses without a year of revenue, the bank will want to see your business plan. A thorough and up-to-date plan demonstrates to the bank that you know your customers, your industry and your growth potential. This can go a long way towards securing financing. A strong business plan includes:
- A detailed marketing section that quantifies demand for your product or services and shows your strategy for business development.
- A risk management section that outlines what your business and personal risks are and how you’ve addressed them.
- A management section to showcase why you and your team will make your business successful.
- Cash flow projections up to 36 months.
If a business loan isn’t accessible right away that doesn’t mean an entrepreneur has no options. Entrepreneurs can start with a personal line of credit using their own individual credit history to qualify.
“Your personal financial situation has an effect on your business when you are just starting out,” says Glambeck. “Brand new entrepreneurs might think they can walk into a bank and get large loans or grants, but it usually doesn’t work like that. Often, a bank wants to see you put some of your own money into the business, showing the bank you are invested,” she says.
And when bank loans are altogether off the table or don’t provide enough capital, entrepreneurs can tap into community programs outside of the bank, says Glambeck.
“Entrepreneurs might have a revolving loan from the bank and a term loan from an organization like Futurpreneurs, Alberta Women Entrepreneurs or BDC,” she says. “It’s quite common for entrepreneurs to use a combination of loans as long as they have the right plans in place to pay the loan back.”
Regardless of how you choose to build out loan financing for your growing business, Glambeck says it’s critical to “crunch the numbers”. You’ll need to determine exactly what your monthly expenses are, what the repayment plan is and how much sales are needed to pay back the loan to keep your business growing successfully.