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Which is Better: Revolving Credit or a Business Loan? 

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Which is Better: Revolving Credit or a Business Loan?

Revolving business credit and business loans are both good options for covering short-term expenses. Short-term expenses can include rent or restocking inventory if demand spikes, time-sensitive expenses like payroll when cash flow is halted due to accounts receivable not coming in, or a deposit to secure equipment that just went on sale when limited supply is available.   

They both have interest payments and fees, and a set amount of money that can be borrowed.  But there are situations where one is more advantageous than the other. 

Knowing when to go with a business line of credit or a business loan comes down to understanding their similarities and differences and being able to project when you’ll have the cash flow to pay them off plus interest. Let’s dive into the comparison. 

  • Revolving credit for businesses is a set amount of money that a business can borrow on an as-needed basis. As the funding is paid back, the total approved amount of financing becomes available again. Revolving credit comes in the form of business credit cards, lines of credit, and other refillable types of business financing. 
  • Business loans come in agreed-upon amounts of funding and are given to a business for a specific purpose. Loans are designed to be repaid in monthly, daily, or weekly installments over a fixed amount of time. When more money is needed, the borrower will either need to reapply for another loan or negotiate new terms on their existing contract to obtain additional capital.  

Both types of business financing are helpful to companies of all sizes. If you’re not sure which one to choose in your situation, we can help. For quick reference, we’ve put together a table that shows how the two products are similar and different, and when to choose either revolving business credit or a business loan. 

The Similarities and Differences 

 Revolving Credit Business Loans 
Amount of funds available is predetermined Yes Yes 
Interest rates Higher Lower 
When interest payments are made Only when money is borrowed and not paid back before the required payback period Throughout the loan term 
Payment terms Typically include monthly minimums  Fixed payments at agreed-upon terms (i.e., weekly, daily, or monthly) 
Ongoing access to financing Yes, until the business closes the account No, borrowers need to reapply for new loans 
Impacts business credit score Yes, if the lender does a hard pull, reports to the business credit bureaus, and if debts become outstanding  Yes, if the lender does a hard pull, reports to the business credit bureaus, and if debts become outstanding  
Good for short-term expenses? (1 month or shorter) Yes No 
Good for long-term expenses? (2 months or longer) No Yes 
Flexible use of funds (1 low – 10 high) 10 7, depending on the lender 
Best use of funds Low-cost purchases and short-term expenses Larger purchases with single payments 

When to Choose Revolving Credit or Business Loans 

Both types of business financing can be used for short- and long-term expenses, and both are great for covering emergencies and investments. But there are instances where one makes more sense than the other and where both can be used in combination. Here are some examples to help you decide which is right for your business. 

Working Capital and Operating Expenses 

You can use the financing as working capital for operating expenses, such as to cover short-term and immediate expenses that are necessary to keep your business running. This can include paying rent or utilities, making payroll, doing small repairs or upkeep on equipment or systems, and restocking inventory.  

Revolving credit is better for operating expenses where you will have the cash flow before the monthly payment is due, so you can avoid paying interest on the money borrowed. Working capital loans are better when you have invoices that will come due after the end of the month, or when it will take you multiple months or years to recover the cash flow. By taking out a loan in this situation, you can save on interest payments.  

If Cash Flow Will Recover Quickly 

When a machine breaks, including an oven in a restaurant or a tractor on a farm during harvesting season, you could choose either financing option. This is because, once the repairs are made, you should be able to make money quickly regardless of the financing option you selected. 

Revolving credit could make sense when the repairs are minor, and your costs will be covered when the equipment is up and running again. A business loan could make sense compared to revolving credit if the costs are high (i.e., higher than your current cash flow allows you to pay up front), since you can get affordable monthly payments. 

An example of when using a business loan over revolving credit is a good idea is when the equipment needs replacing instead of repair because it is old and is likely going to break again. If the new equipment takes multiple months or years to pay off, you’ll save more money and free up more cash flow by using a loan, since revolving credit interest rates tend to be higher.  

Any situation where you need the machine working asap so business can keep moving, and you’ll be making payments over time as the expenses are larger, will make business loans the better choice compared to revolving credit. Situations where you’ll be able to pay the total amount before interest payments are required are instances where you’re better suited to choose revolving credit over a business loan. 

Recovering from Emergencies (Emergency Financing) 

The process of deciding between using revolving credit or a business loan depends on the level of damage and what it takes to get operational. If it’s a matter of paying a clean-up crew, replacing some computers, and paying a week or two of salaries, revolving credit is a good option because it is available as you need it and can come in handy if more issues surface. With a loan, if you don’t get the right amount of funding up front, you may slow down your progress, since you’ll need to go back, reapply, and get approved all over again if other issues come up later. 

In these situations, your business could be profitable again in the short run, and you’ll likely be able to pay off the funds in a month or two, keeping interest payments to a minimum. If you need to find a new office, cover a month of payroll, and replace machinery or inventory—all of which are more substantial costs—you’ll likely want an emergency business loan instead. The financing can be approved quickly when you use alternative lenders, and you can make fixed payments with a set interest rate to keep cash flow predictable while your business recovers.   

Mixing and matching the two types of business financing could also make sense in certain emergencies. For larger expenses like replacing production equipment or vehicles, you can use a small business loan, while you also take out revolving credit to cover smaller expenses like the cost of the clean-up crew and replacing computers. If you use a business credit card, you may earn rewards or cash back, helping to lighten the burden of unexpected expenses. 

Investments 

Using business financing for investing is another situation where both types of credit can make sense. For long-term investments like a building, new or upgraded equipment, or expansion into new markets, you’ll want to go with a business loan. These investments often take longer to turn a profit, so the set payments with typically lower interest rates will help keep your cash flow more stable while the investment begins to turn profitable. 

Investing in employees (i.e., sign-on bonuses), operations (i.e., you find a limited-time deal on a system and software upgrade), and vendor relationships (i.e., loaning money to a trusted vendor where they will pay you back quickly) could all be good situations to use revolving credit. To continue the example: If lending money to the vendor results in larger business deals with more profit, one or two months of interest paid on revolving credit may be worth the temporary loss for the long-term gain. These investments typically pay back quickly, so revolving credit works well. 

Small business loans and revolving credit are both good for covering short-term and operational expenses. If it takes longer to get your money back, a business loan will be better than revolving credit because the typically lower interest rates keep your cash flow intact. However, if you project that you’ll have the revenue to pay off your financing before the interest payment is due, revolving credit is better than a business loan because you can avoid paying interest. 

SmallBusinessLoans does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors. 

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