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Small business loan versus business line of credit

DLP

How a small business loan and a business line of credit work and what they may be useful for.

At a glance

Here’s a snapshot of the article’s advice:

  • A business line of credit and a small business loan are two of the most common external funding options.
  • A line of credit is an ongoing source of funding that can be drawn back down as it is repaid and may help manage fluctuations in cash flow.
  • A business loan is a lump sum amount that you receive on the day the loan term begins and can be useful to fund large purchases such as equipment.
  • Remember to consider your business’s needs before applying for external funding, and which option may be most suitable.

If you’re a small business owner looking for funds to grow your business, boost your cash flow, or top up your working capital in response to economic concerns, there are different options available.

The two most common are a business line of credit and a small business loan. It’s important to understand how they work and what they may be useful for so you can pick the external funding option that is right for you.

How a business line of credit works

A business line of credit is an ongoing source of funding that can be drawn back down as it is repaid – rather than a lump sum that is paid off.

Once you’ve been approved to access a line of credit, you can draw down on part or all of the funds during the term of the facility, which is usually 24 months. You only pay interest on the money you have used, for as long as you use it.

So, if you have a $20,000 line of credit, you could draw down $10,000 one week and repay the money the following week, only accruing interest on the money you’ve accessed until it is repaid. It’s a bit like a credit card but may come with lower interest rates and can be a useful safety net if your cash flow is unpredictable.

A line of credit is usually – but not always – a form of unsecured debt, so borrowers are usually not required to put up collateral.

“The [Prospa] Line of Credit was like a security blanket while we trialed and tested our new business model.” – Lily Kahramanian, Workdog Creative

What a business line of credit is useful for

A business line of credit may help manage fluctuations in cash flow.

For example, it could help when cash flow dips due to an off-season lull in business but you need to keep on top of payroll, or if you anticipate a delay in payment from clients.

It can also work as a short-term top-up to working capital so you can take advantage of a particular opportunity, like a good deal on a bulk buy of inventory, or for covering the costs of paying extra staff over a busy period, funding rent on a pop-up space, trying out a lease on a co-working space, or funding repairs to equipment.

In summary:

  • A business line of credit is an ongoing source of funding that can be drawn back down as it is repaid.
  • A line of credit may help manage fluctuations in cash flow.

How a small business loan works

A small business loan is a lump sum amount that you receive on the day the loan term begins.

It comes with a schedule of regular repayments, and there may be restrictions on whether the full amount can be paid back early. Typically, you will need to pay interest on the outstanding debt throughout the term of the loan.

Business loans will usually be higher amounts than lines of credit, and some do not require collateral. Larger business loans may require collateral.

“[Prospa Small Business] Loans have given me the ability to expand the range [of Ugg boots], as I’ve wanted to add in new products, and it’s given me the ability to order larger quantities, through my pre-season orders.” – Craig Taplin, Aussie Soles

What business loans are useful for

Because business loans are usually available for larger amounts than a line of credit, they can be useful to fund large purchases such as equipment. They can also be a good solution to spread out a sizable one-off expense – such as an office renovation or shop fit-out – that needs to be paid upfront.

A business loan may be used for start-up costs, capital investment, business acquisition, marketing campaigns, purchasing new or second-hand equipment, starting a franchise, purchasing commercial vehicles, technology upgrades, and refinancing other debt.


In summary:

  • A business loan is a lump sum amount that you receive on the day the loan term begins.
  • A loan can be useful to fund large purchases such as equipment.

Remember to consider your business’s specific needs before applying for external funding, and which option may be most suitable.

While a business line of credit can also be used to fund inventory costs or to take advantage of a one-time deal on discounted stock, for instance, a line of credit could also be suitable for those needs.

This article was originally published in January 2022 and has since been updated.

A Prospa lending specialist can help explain how a Prospa Small Business Loan or a Prospa Business Line of Credit can help your business grow or respond to economic pressures.

The information in this post is provided for general information only and does not take into account your personal situation. Nothing contained in this post constitutes advice or an endorsement or recommendation of any kind by Prospa. Any links to third party websites are strictly for informational purposes only. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from financial, legal and taxation advisors. Although every effort has been made to verify the accuracy of the information as at the date of publication, Prospa, its officers, employees and agents disclaim all liability (except for any liability which by law cannot be excluded), for any error, inaccuracy, or omission from the information for any reason, including due to the passage of time, or any loss or damage suffered by any person directly or indirectly through relying on this information.