Establishing and running a business require continuous inflow of cash, both for long-term and short-term use. There are different avenues of financing available for a business owner depending upon their need; be it the duration of financing required, interest rate charged, the ease of obtaining the finance, etc.
Financing could also come in the form of equity, but it would require the business owner to give up some control and ownership of the company, which may not be feasible for the owner. Small businesses need to put in lot of efforts in building up the business and therefore, look for easier, simpler and cost-effective methods of obtaining finance for their businesses.
One of the questions that our customers ask us at CreditMantri is: Business loans or business credit card- Which is a better method of financing the business needs.
At the outset, the answer to this question will depend on the ultimate purpose of the funds, the interest rate charged, and the credit score of the individual or the business. However, we would like to make credit matters easier for you to understand so that you can take an informed decision on which kind of financing will suit you better.
We will analyze both the options in detail to make the decision making easier for you.
Let us begin with the Business Loans
Business Loans are availed from traditional lenders like banks and NBFCs, or could also be availed from fintech lenders. These loans are set for a particular tenure during which the loan is repaid in EMIs. The amount of loan can also vary depending upon the need of the business, its repaying capacity, and other factors like the soundness of business financials.
Business loans are useful for purchase of long-term assets like office space, machinery or to repay an existing debt.
Advantages of a Business Loan
Bigger amounts of money can be borrowed: A business loan allows you to avail bigger amounts of finance, which may be required for building fixed assets for a business. The amount of loan offered under a business loan are decided on a case to case basis depending upon business financials, collateral provided, general economic conditions of the country, etc. This comes across as the suitable method of financing if a business is looking to buy fixed inventory, office or factory space, heavy machinery and other assets which need bigger amounts of cash outflow
- Longer tenures are allowed: When a business looks at buying fixed assets which cost significantly, repaying the loan for the same over a longer period of time makes sense. Business loans provide finance which will need to be repaid over a longer period of time. Repaying huge amounts of loans over shorter time periods may add to the financial burden
- Interest rates are not high: Though business loans are priced higher than retail loans, they still fall under the affordable range. Generally, business loans are priced in the range of 12-26 %. They are still cheaper than credit card APRs which can go anywhere from 24-48%.
Disadvantages of a Business Loan
- Might be difficult to qualify for one: Small businesses are still in the formation stage and may find it difficult to make themselves qualify for a business loan from a traditional lender. These lenders usually demand a horde of documents and have a stringent set of conditions to lend to a business.
- Collateral may be required: Business loans are big-ticket loans and hence, the lenders incur more risk in lending. To compensate for the risk involved in lending, lenders often demand for assets like machinery, office space or even shares in the company as security or collateral. A service-oriented or small business may find it difficult to meet these criteria.
- Credit Score matters: A business loan is approved on the back of a good credit score. However, a small business might still be building their credit portfolio and may not have credit history to demonstrate their creditworthiness.
- Time for disbursal of the loan might be longer: Business loans are approved only after a lot of due diligence. This may extend for longer periods in case of small businesses as they may not be able to produce all the documentation required at one shot.
Business Credit Cards
Business Credit Cards come across as an instant means of finance, without having to wait for processing or disbursal time. Once the credit cards are approved and issued, their usage needs no approval which can act as a plus point for the business owner. Usage of business cards may also make you eligible for rewards points, cash-backs and other partnership deals that usually accompany a credit card.
Advantages of a Business Credit Card
- Instant Finance: A business credit card can be used as a means for securing instant finance. A small business owner may often find himself struggling with cashflows due to a variety of reasons. A credit card may help them in easing those concerns.
- The amount can be availed at 0% interest: As long as the business is able to pay back the money within the date of clearing the outstanding dues, the amount used comes at 0% interest. Depending upon the date of usage, the business may get a credit period of anywhere between 15-45 days on a credit card.
- Multiple cards can be issued to employees: Multiple business cards can be issued to employees with set limit, which can help them manage their own expenses. This can avoid a centralized system of accounting which can help the small business in mitigating its overhead human resources costs.
- Easy tracking of spends is possible: As a bill is sent across at the end of every billing cycle, it becomes easier for the businesses to keep track of the expenses. Credit Card bills often give split up amounts for various categories of spends, like dining, fuel, travel, etc.
- No collateral is required: A small business or service-oriented business may not have assets to pledge as collaterals for loans, hence making it difficult for them to avail business loans. They don't need any collateral for availing credit on a card.
Additional Reading: Why you need a business credit card
Disadvantages of a business credit card
- The interest charged on non-payment of dues is enormous: If the amount spent on a credit card is not paid by the specified due date, the interest to be paid on the amount is very high. In fact, credit card debt is the most expensive debt. A small business will find it really difficult to get out of the debt spiral of a credit card. Hence it is best avoided.
- Shorter periods of financing available: The period of credit allowed by a credit card may prove extremely short for managing business finance needs. At the best, it can be used for sailing through shorter periods of financial crunch or as a gap-fill finance.
- Credit utilization ratio and credit score may be at stake: If the credit card is extensively used for business needs and ends up maxing out the limit on the card, then the credit utilization ratio as well the credit score of the business may be at stake. This may prove detrimental to a small business.
Having seen both the options, we are of the opinion that business credit cards may be used by a small business owner to overcome short periods of credit crunch, but for financing bigger projects or assets, business loan might be the option to go to. However, these days there are many fintech lenders who offer flexible business loans at less stringent conditions than a bank, which may prove worthwhile for a small business owner.
Additional Reading: All You Need to Know About Business Credit Card Rewards