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Does my business need an operating line of credit or a term loan?

Does my business need an operating line of credit or a term loan?

Posted on: January 14, 2012
Author: ATB Business & Agriculture

As a new business owner, financing options are sometimes confusing.

It’s tempting to use your business line of credit in the same way that you would for your personal finances—for almost everything. But that can sometimes create serious cash-flow problems for your business. Both borrowing options have advantages and disadvantages that should be considered before you make your financing decision.

What is an operating line of credit?

An operating line of credit, sometimes referred to as a revolving line, works in the same way as a personal line of credit but typically has a higher minimum borrowing amount. While you may be able to get a personal line of credit for only $5,000, an operating line of credit is usually available for $50,000 or more. You have access to these funds, but you only pay interest on what you use. Repayment terms are extremely flexible, and a revolving credit arrangement means that you don’t need to reapply.

What is a term loan?

A term loan is simply a sum of money that you can borrow for specific business expenses and repay over a period of time, usually up to a maximum of 20 years. You can choose between a fixed and variable interest rate and a variety of repayment schedules.

Key differences between an operating line of credit and a term loan

Operating Line of Credit Term Loan

Typically used for short-term operating capital needs

Typically used for long-term expenses such as fixed assets

Variable interest rate

Fixed or variable interest rate

Higher minimum borrowing amount

Lower minimum borrowing amount

Pay interest only on what you use

Pay interest on the entire loan amount

Often secured with inventory and receivables

Secured with equipment or real estate

Remains available to you after you use and repay it

Need to reapply if you require more financing

Which option to choose?

An operating line of credit is ideal for your regular operating expenses. Having extra funds available to your business will improve your cash flow, and you can avoid the higher cost of term loans for short-term capital expenses. You probably don’t want to use your operating line to pay for business assets or equipment that will take years to pay off, because it ties up those funds for that period of time. This could create cash-flow problems.

A term loan is ideal for expenses that will take longer to pay off, leaving your operating line of credit available for operating expenses.