Business Finance vs line of credit: What are the differences?

Updated On November 7th, 2023By Dynamoney

As a business owner, there are two main options of finance to consider: business finance vs line of credit. Before you decide what is the right option it is important to understand the differences between each so you can determine which solution is right for you. In short, business finance is an ideal solution for businesses looking to secure a significant amount of funding for a one-time purchase, or a specific need or project. Whereas a line of credit is usually best suited to businesses looking to improve working capital or even out cash flow on a need-to-need basis.

What is business finance?

Business finance is an overarching term that covers a variety of different finance options including business loans, invoice finance, trade finance, insurance premium finance, as well as vehicle and asset finance. Most business finance products can be structured as secured or unsecured loans. In the case of a secured loan, the asset you are borrowing the money to purchase acts as collateral against the loan, often negating the need for a deposit. Whereas an unsecured business loan doesn’t require an asset to act as collateral but will typically require you to pay a higher interest rate.

One of the most common types of business finance is a business loan, which provides a business with a one-off lump sum payment that can be used to purchase a specific asset or fund a specific need. As the borrower, you will be required to pay back the amount borrowed plus interest over the loan term through a series of set repayments.

Like a business loan, asset and equipment finance are used to fund the purchase of required machinery, vehicles or other specific assets. Unlike business loans these types of finance allow you to opt for a balloon payment at the end of the loan term, which can help to reduce the amount of your repayments.

Insurance premium finance is a lending solution specifically designed to help businesses spread out their lump sum insurance payments over a period of time, to ease the pressure on cash flow.

What is a line of credit?

A line of credit allows a business to access finance up to an agreed limit each month and is typically used to increase working capital. With a line of credit, there are no limitations or restrictions on how the funds must be used and interest is only payable on the amount of money borrowed.

Repayments tend to be flexible with a line of credit giving you the choice to clear the credit balance each month or only make the minimum required repayment. Once the borrowed funds have been repaid that amount is available to borrow again. Simply put, a line of credit allows you to access the money as you need it up to a certain limit.

A lot of the time a line of credit will be linked to other financing solutions such as invoice finance. In this instance when you raise an invoice an agreed percentage (e.g. 85%) of the invoice amount is added to your line of credit. When the invoice is paid, the credit is repaid.

Business finance vs lines of credit, how are they different?

Now that we have looked at what business finance is and what is a line of credit, it is important to understand the key differences between the two.

Fees & interest rates

Lines of credit typically have monthly withdrawal fees whether or not you choose to access the credit available. Depending on the type of business finance chosen you might be subjected to higher interest rates as the lender is taking on more risk, as is the case with an unsecured loan.

How the funds can be used

Business loans are generally used for a specific need or purchase and in most cases as part of the application process, the lender will ask you what you plan to do with the funds if your application is successful. With a line of credit, there are no restrictions as to what the funds can be used for.

Reapplication

With a business loan, if you discover down the track that the amount borrowed isn’t enough, you will have to reapply for a larger loan. Whereas a line of credit acts like a revolving loan, which allows you to draw money up to a certain limit. Each time you pay back the money you owe, you free up more money to borrow without having to reapply each time.

Eligibility requirements

Certain types of business finance require you to put up collateral against the loan.

Business finance vs line of credit: How to choose?

When choosing between business finance vs line of credit, ask yourself the following three questions.

What do I need the finance for?

If you are looking to purchase a particular piece of equipment or update a company vehicle, business finance is likely to be the most suitable option. On the other hand, if you are looking to cover short term expenses and alleviate cash flow stress, a line of credit would be the better choice as it allows you to borrow only the amount you need each month. Plus, it also has the added flexibility on how the repayments can be made.

How much funding am I looking to secure?

If you require a large lump sum amount to finance a one-time purchase that will help you to grow your business, then a form of business finance such as asset or equipment finance, or a secured or unsecured business loan is an ideal option.

What type of repayments are you looking for?

One of the key differences to understand when considering business finance vs a line of credit is how the amount being borrowed is repaid. Repaying a business loan generally involves a set number of monthly repayments that don’t differ over the life of the loan. As mentioned above, a line of credit offers more flexibility when it comes to repayments. As long as you repay the minimum amount required each month, you can decide how much you repay.

For further assistance to decide which is the best option for your business, contact one of our lending specialists today on 1300 001 420, or fill out our online enquiry form.