When the time comes to fund your operation, the number of new terms and complicated concepts related to small business finance can be overwhelming and hard to know if you are making the right choice.
You should research beforehand so you can explore the options and you will see that small business financing is complex. Start your research with this list of some of the most common small business financing terms.
Defining Common Small Business Financing Terms
These basic small business loan terms are what every small business owner needs to know before applying for a loan. This will help you make the best financing decision for your business.
Before applying for additional working capital, you should be as knowledgeable as possible. The key terms below are important for you to know and understand.
APR is Annual Percentage Rate which refers to the interest rate of a line of credit or loan including the total cost of annual monthly fees. Many business owners confuse a loan’s APR for the interest rate before although these two terms are linked, they are not interchangeable.
The interest rate is almost always lower than the APR. Small business financing with 10% interest rate doesn’t include common fees such as application, origination, monthly administrative, annual or SBA guaranty.
Small business loans have more fees than individual consumer loans, so the interest rate and APR is much greater. When looking at different financing options, APR is a good way to see which choice will be less expensive in the long run.
A term loan is the common type of small business financing. Term loans have a set payoff date and loan amount. In addition, they have a fixed or variable interest rate.
There are two types of long-term and short-term small business loans. A short-term loan has a term of one-year or less, while a long-term loan may last closer to 10 years. Some loans may even offer 20-year terms. Businesses can choose their term when they apply for a loan.
Term loans with fixed interest rates will have the same monthly payment while variable-rate term loans will have a different monthly payment when the interest rate changes. Businesses can also take out term loans with balloon payments where initial payments are low with a much bigger payment on the end.
Line of Credit
A business line of credit is when a business lender provides access to a certain amount of money that the business draws from. The business has to repay the amount borrowed in installments, during a loan repayment term. Unlike a loan with a fixed term, a line of credit has no end date.
As long as the business makes payments on time, the business line of credit will remain open and available. This is a popular alternative from a traditional small business loan, because there’s more flexibility.
Factoring is a financing option for companies that prefer not to take out loans or lines of credit. It involves selling a customer invoice to a third party instead of waiting 30 days or more for the customer to pay.
The company receives 70 to 90% immediately from the third-party. Once the customer pays, they will send the remaining amount to the company.
One downside to factoring is that companies don’t receive 100% of what they invoice for. This can be a major problem for companies with narrow profit margins.
Merchant Cash Advance
For companies that have a hard time qualifying for small business loans, merchant cash advances can be a valuable gateway to get money.
If a company is approved for an MCA, they will get the funds within 72 hours. Instead of making regular fixed payments like a traditional loan, the lender receives a portion of the company’ credit or debit transactions until their obligation is fulfilled.
The Bottom Line
Part of being a small business owner is understanding trends and vocabulary related to your industry. Your business will suffer if you do not use the current language in the finance industry. The better understanding you have on the terms, the better you will be able to understand your options.