Expensive Small Business Credit and How to Avoid It

The longer you’ve been in business, the more likely you are to know that credit is necessary for a small business to operate. It allows for expansion, improves profitability and increases operational efficiencies. It also makes it possible for smaller businesses without big bank accounts to meet their daily expenses when they have a cash crunch. While credit is essential to a small business’s operations; it is equally important for small businesses owners to consider the cost of their credit. (You didn’t think the cost of credit was the same for everyone, did you?)

One of the important factors that affect the cost of credit, is time. Many small businesses need quick credit decisions, and they often don’t have a long credit history or major assets to use as collateral to receive credit. As a result, they end up paying more than they should to access secure funds when needed.


The Cost of Expensive Credit

While credit is necessary for small business growth, expensive credit isn’t worth using. Paying excess interest and fees to access credit can counteract the benefits achieved from obtaining credit, and can actually ruin a small business’ financial position rather than improve it.  The common credit options available to small businesses include merchant cash advances, credit cards, lines of credit, and loans. Merchant cash advances, credit cards, and lines of credit may be more accessible to small businesses, but they have major pitfalls: they are prime examples of expensive credit.


Types of Credit for Small Businesses

A merchant cash advance is a quick way for a small business to get desperately needed cash, particularly by those with bad credit or lack of a credit history. While merchant cash advances are beneficial in that approval is somewhat easy, the fees on these cash advances can be astronomical, and can even continue to cost you money after your balance is paid. They should only be used when a company is in a major bind.

Another option for obtaining credit is using business credit cards. These are not ideal for making larger purchases, because they commonly have high interest rates, but are instrumental in establishing credit that isn’t tied to your personal accounts. Credit card debt can serve up a double whammy when it comes to costs because if you don’t pay off the balance each month, the interest compounds. For example, if you charge $5,000 on a credit card with a 20% interest rate and make a $100 per month payment, it will take you 100 months to pay off the debt and you will end up paying back $10,900!*

Another, slightly better option than the already discussed options is a line of credit. A business line of credit provides you with capital to draw upon to meet a variety of business needs. However, it is harder to gain approval for a line of credit than a high interest credit card, and definitely more difficult to access than a merchant cash advance. With a business line of credit, you can draw it down as needed to access more capital. Lines of credit are meant for short-term expenses, and are not intended to be used to fund large one-time purchases, because interest and fees need to be paid based on the amount that has been accessed. Paying off these (typically) large monthly sums immediately after receiving your line of credit can put a strain on the business owner who is trying to manage daily cash flows. Usually the term on a line of credit is shorter than a conventional loan and the interest rates are higher.

For small businesses (in terms of cost) a bank loan is one of the best sources of financing. However, two major downfalls of a bank loan is convenience and accessibility. Big banks often take a long time, sometimes many months, to evaluate a business’s loan application. This can include weeks or months of preparation for the business owner to submit the documents required by the application process. For small businesses, even after waiting all of this time their loan request can still be denied due to lack of credit history, not enough revenue, or imperfect credit. If the loan application is eventually approved, the funds often arrive too late to be used for what the business originally intended. Fortunately, there are other options for small businesses.


Finding Faster, More Affordable Sources of Funds

For businesses that are seeking a faster application process, affordable payments in smaller increments, and with a more flexible set of requirements, is a small business loan from a company that specializes in lending to small businesses. At IOU Financial, we specialize in small business loans, and offer a no risk application, instant pre-approval, and easy daily payments. We understand how important the speed of credit decisions can be and that you may not have perfect credit or a long history to back up your request. We will look each business’ unique situation, make a full decision in under 24 hours.


*interest calculation https://www.creditkarma.com/calculators/debtrepayment