Business Finance vs Line of Credit: What’s the difference?

If your business needs a cash injection, you have two main options. You can seek Business Finance or a line of credit.

Generally, Business Finance is the better option when you need funding for a significant one-off purchase or a specific reason.

A line of credit is more suitable if you need to support working capital as your business grows or you want a financial safety net in case of an emergency.

But there are several other differences between these two funding options.

In this guide, we’ll closely examine how these types of financing work so you can discover which is best for your business.

What Is Business Finance?

Business Finance is an umbrella term that covers a range of funding solutions. These solutions range from property-secured funding facilities to short-term equipment financing.

A Business Loan is one of the most common financing types. The lender will provide a lump sum your business can use to expand, purchase inventory, or refinance existing debt.

Most business loans are secured with residential property. The principal plus interest is repaid over a series of repayments.

Asset Finance is a type of business funding designed to help companies purchase the equipment, vehicles, and other assets they need to grow. Instead of buying an asset upfront, you can spread the cost over a more extended period with affordable repayments.

Trade Finance is a type of finance that helps businesses to purchase new inventory without stretching working capital. It can be used to fund domestic and international purchases and is often combined with cash flow funding solutions like Invoice Finance.

What Is a Line of Credit?

A line of credit is a type of funding that allows a business to access financing up to an agreed limit. There are no restrictions on how you can use the funds, and you only pay interest on the amount of credit you use.

In most cases, repayments are also flexible. For example, you can choose to clear the credit balance each month or make the minimum required payment. As you make repayments, the amount of credit you can access increases up to the agreed limit.

A line of credit is often linked to an Invoice Finance facility. You can link your accounts receivables to a line of credit.

When you raise an invoice, up to 95% of the invoice value is added to your line of credit. Then, when your customer pays the invoice, the credit is repaid.

A line of credit is mainly used to support working capital. You can use the funding when needed without having to reapply or negotiate new terms with your lender.

Key Differences Between Business Finance and Lines of Credit

While Business Finance and lines of credit can both provide a cash injection for your business, there are significant differences between the two types of financing.

A line of credit is an open-ended form of financing. It allows you to carry a balance and offers a more flexible repayment schedule.

As long as you make the required minimum payment, you can choose how much you want to repay each month. You’ll only be charged interest on the credit you use. If you don’t use the facility, you won’t have to pay any interest.

With Business Finance, you typically access a lump sum upfront and make regular repayments on the principal and interest. Generally, you start paying interest on the total amount as soon as you receive funding.

In most cases, Business Finance is also limited to specific uses. For example, Asset Financing is used to purchase new or second-hand equipment, not to cover overheads or payroll when you’re experiencing a cash flow gap.

With a line of credit, there are no restrictions on how you can use the funds. You can use the credit for any business purpose.

Which Type of Financing Is Right for Your Business

We’ve covered how these types of financing work and how they differ. Now let’s look at which businesses can benefit most from the two types of funding.

Business Finance is typically more suitable for specific one-off expenses, such as purchasing inventory, buying equipment, or expanding by taking on new staff or opening a new location.

There is a range of Business Finance solutions that are designed for specific purposes. You’ll need to know what you plan to do with the financing and how it will help you grow your business to know which is most suitable for you.

For example, if you need capital to buy inventory to capitalise on peak seasonal sales, Trade Finance could be the ideal funding solution.

A line of credit suits businesses that need ongoing funding to support working capital. According to the Australian Government Productivity Commission, maintaining cash flow is the number one reason why companies seek debt finance: Source – Australian Government Productivity Commission

Many types of Business Finance are not suitable for cash flow funding. For example, in the case of a Business Loan, you’ll have to pay interest on the entire loan amount, even if you initially only use a fraction of total funding to improve liquidity.

Generally, a line of credit benefits businesses most when it is used for short-term funding needs. You can access funding as and when you need it and only pay interest on the credit you use.

This makes a line of credit more suitable for ongoing operating costs, unexpected outgoings, and temporary cash flow gaps.

Things to Consider With Business Finance and Lines of Credit

There are several factors to consider when determining whether your company could benefit more from a line of credit or Business Finance.

How Much Funding Do You Need?

A line of credit linked to your accounts receivables using Invoice Finance is limited to the amount of money owed to your business in outstanding invoices. That’s typically more than enough to cover a cash flow gap or unexpected expense.

If you own a property you can use as collateral, you may be able to increase your credit limit using a working capital solution like Business Cash on Call. It’s a flexible line of credit that can be secured by the equity in your home.

However, if you need a significant lump sum to pay for a one-off purchase, a Business Loan, Asset Finance, or another type of Business Finance may be more suitable.

How Do You Plan to Use the Funding?

If there is a specific purpose for the funding, you may benefit more from financing designed for your particular needs. For example, if you want to purchase new machinery or a vehicle, Asset Finance is usually more suitable than a line of credit.

If you need funding to increase liquidity during a period of fast growth or a cash flow gap, a line of credit is the better option.

What Are Your Repayment Preferences?

Business Finance repayment terms are typically more predictable than a line of credit. In most cases, you’ll have set monthly repayments. This can help you to plan and predict your cash flow.

With a line of credit, the repayment terms are more flexible. As long as you make the minimum repayment, you can choose how much of the credit you want to repay each month. You’ll be charged interest on the amount you use, but this does provide flexibility to help you manage working capital.

The right choice will depend on your unique business circumstances. You’ll need to consider your options and determine which funding solution will help you meet your business goals.

Obtaining Business Finance

Now you should have a better understanding of the different funding solutions you can get for your business. Lines of credit and Business Finance are tools that can help you grow and succeed.

If you need some help working out which funding option is right for you, give us a call or send us an email enquiry. Our Business Finance experts are on hand to help you understand your options and secure the funding your business needs to thrive.