10 pros & cons of short-term financing for SMBs

Small businesses in need of funds often turn to bank loans as a first option. But while banks are a vital part of the SMB financing landscape, traditional loans haven’t always been the best way to solve urgent needs. 

Today, you likely have better choices when unexpected costs arise or your cash flow cycle becomes sub-optimal. These options are broadly labeled “short-term financing,” and many are designed specifically to help SMBs in the immediate term. 

Of course, there are real pros and cons to these too, just like any financing instrument. 

This article looks at the best (and worst) aspects of short-term financing, to help you decide whether this is a good option for your business. 

What is short-term financing? 

Short-term financing is a business loan or line of credit with payment due in the near future—typically within three to six months. Any kind of loan or credit to be repaid within a short time frame could be considered short-term financing. But in general, we’re talking about options other than conventional loans or your bank overdraft facility.

This is in contrast with startup or small business loans, which are often repaid over the first few years of operations. It’s also different from venture capital investments, in which investors may recoup their costs during further fundraising rounds or when the company is sold (or goes public).

Short-term financing can be great for small businesses with relatively urgent funding needs. This includes buying stock, paying seasonal staff, or launching limited-time marketing campaigns. 

Types of short-term financing

The most common forms of short-term financing include: 

• Factoring. In a factoring arrangement, you transfer some or all of your receivables (unpaid customer invoices) to a third party (the factor). In exchange, the factor gives you immediate credit to use as you need. The factor collects outstanding payments from customers directly. 
• Invoice financing. Invoice financing or discounting lets you receive payment in advance for your receivables. It’s different from factoring in that you keep control of your invoices and are responsible for collections. The invoices are there as proof that you will receive payment in future. 
• Accounts payable financing (or inventory financing). Accounts payable financing lets you borrow funds against outstanding supplier invoices. For a fee you’ll pay in future, a third party gives you cash upfront to buy goods or services.
• Revenue-based financing. Revenue-based loans are a line of credit which will be repaid as a percentage of your future income generated (within a fixed period of time).

For more information on the above, read our guide to the different types of short-term financing. 

Advantages of short-term financing

Compared with traditional bank loans, short-term financing has some key benefits. 

1. Fast application process

Because conventional loans are a longer-term commitment, they often involve more paperwork and due diligence to secure. That’s even more the case for venture capital investments, which are treated like a partnership that can last years or decades.

Short-term financing still involves due diligence, and some factoring agreements are known to take months to secure. But in general, the application process should be faster and less cumbersome. 

Ideally, you’ll complete your application and find out whether you’re eligible right away. Some providers, like Defacto, can have you set up in under 27 seconds. 

2. Immediate access to funds

Since the application process for short-term financing is typically fast, you should also have funds in your accounts in short order. This isn’t always guaranteed with conventional loans, which can include additional sign-off and even stand-down periods. 

And you should be able to renew and refinance just as quickly. As long as you meet your obligations, providers will gladly offer you more funding when the time arises. Smart businesses can fund working capital on a revolving basis this way, and keep reinvesting in their own growth. 

3. Optimal cash management

The chief reason for seeking short-term financing is that you lack necessary funds. That includes both paying staff and suppliers, but also making timely investments that will earn you money in the long run. 

But you can also use quick cash injections to improve your cash conversion cycle. Get paid now for invoices due in future (as with invoice financing), and you effectively reduce your “Days Sales Outstanding”—a critical element of healthy cash flow. 

4. Easy repayment process

A short-term loan implies a quick repayment window. This helps to limit the amount of interest you owe, and keeps debts from lingering too long on your balance sheet. 

That’s in contrast to some traditional lenders who prefer to hold debts as long as possible. They may even penalize you for early repayments, and can make the repayment process administratively complex. 

You want the flexibility to repay as soon as it makes sense. 

5. More flexibility

It’s rare to get a loan for the exact amount you need, with the terms you want, to use as you like. Most often, lenders present a package that suits them first, and hopefully still works for you. 

Not all short-term funding options are highly customizable, but you have a wide range of options. If factoring doesn’t suit you, why not try inventory financing instead? 

Modern providers let you use funds as you need them, however is best for you. And with such short commitments, you’re not stuck in an inflexible agreement for long. 

6. Respond to current challenges

We touched on this above, but it’s worth repeating: short-term financing responds to your most urgent financial needs. You could be caught short after a slow summer, or have an exciting opportunity you want to take advantage of. Neither of these situations is suitable for a long-term loan. 

Really, it’s best to think of bank loans and venture equity as your big, forward-looking funding agreements that set you up for years. You use these to double your workforce or expand into new markets. 

For the more timely, real-time cash flow needs, think short term. 

Disadvantages of short-term financing

There are some good reasons why you might not seek short-term funding. While they’re often an excellent choice, there’s no such thing as a free lunch. 

The potential downsides include: 

1. High fees and interest rates

This isn’t the case across the board. For example, Defacto has no hidden fees and charges just 0.05% per day. You can repay at any time, so it’s easy to keep the interest amount in check. 

But some options, including factoring and certain invoice financing providers, are known to charge higher rates. Factoring can cost anywhere from 0.5% to 5% of the invoice value, plus a commission (interest) and administrative fees. You may have fees to cover the collections process, for example. 

These additional costs can be well worth it if the funds are used wisely. But they’re worth considering in advance. 

2. Credit sizes will be limited

This isn’t necessarily a bad thing—you would never borrow hundreds of thousands and expect to pay it off in months. But it’s a factor to consider: most short-term loans will be somewhere between a few thousand to low tens of thousands. Enough to cover immediate staff and resourcing costs, pay suppliers, or launch a local advertising campaign. 

But you can repay each loan and then refinance again quickly. And with each timely repayment, you can expect lenders to offer more credit and friendlier terms. 

Used responsibly, this is a great way to grow without eating into precious savings—the company’s or your own. 

3. Borrowing can become a cycle

Used strategically, a careful debt cycle can be a good thing. Say you have peak seasons that require extra resources, but you don’t see the rewards until months later. This could be true for advertising agencies that work overtime leading up to the holidays, but clients pay three months later. Or for produce growers, who work hard during the harvest but whose stock takes time to sell. 

But there are also those companies that get into debt, then use more debt to get themselves out of it. With each loan, the interest and fees grow, and the hole becomes deeper. 

‍Smart businesses use debt as a tool with a very clear strategy, and a contingency plan should they need it. 

4. Debt is inherently risky

Going into debt always comes with some potential risk, even if only in the short term. If you struggle or fail to pay in time, you’ll have fees and increasing interest. Even worse if you need to use further debt to cover your current liabilities. 

You should always study the risks closely and carefully consider whether taking on debt is worth it. And absolutely think twice before putting up essential property as collateral (including personal guarantees).

Is short-term financing a good fit for your SMB? 

Only you can truly answer this question. It depends entirely on your company’s performance, your current funding situation, and your approach to taking on debt. 

But in general, short-term loans are a good option for companies that: 

• Have urgent financing needs
• Want more flexibility and fewer long-term commitments
• Know exactly how they’ll use a quick cash injection
• Have unpaid invoices (both their own and customers’) to borrow against

That applies to a wide range of small businesses, including hospitality, services (and agencies)

If most (or all) of the above applies to you, fast, flexible financing is available. Find out if you’re eligible and how much you can borrow, and start making your cash work for you.