Introduction
As a business owner, understanding the financial products available to you is key to making informed decisions that can help scale your company. There are many types of SME loans available today, each used for different business goals. Two popular financing options for businesses—term loans and revolving credit—offer different structures, advantages, and are suited for distinct business needs.
A term loan can provide the capital injection necessary for long-term investments like purchasing equipment or expanding facilities. On the other hand, revolving credit offers a more flexible solution, often used to cover operational expenses or manage short-term cash flow gaps.
This article aims to break down what is the difference between term loan and revolving credit, helping you determine which type of financing best aligns with your business goals.
Definition of Term Loan and Revolving Credit
What is a Term Loan?
A term loan is a traditional form of business financing where the lender provides a lump sum amount of money to be repaid over a specified period, with interest. These loans typically come with fixed interest rates and scheduled payments, making them ideal for large, one-time investments. For instance, a business looking to purchase machinery or open a new branch might opt for a term loan because it requires a large upfront capital and can repay in fixed installments over several years.
What is Revolving Credit?
Revolving credit, often referred to as a credit line, offers much more flexibility. It gives businesses access to a set credit limit, from which they can draw whenever they need funds. Unlike term loans, interest is only paid on the amount borrowed, not the entire credit limit. The business can repay and reuse the credit, making revolving credit ideal for businesses with fluctuating cash flow needs. For example, a business may use revolving credit to cover operational expenses during low-revenue months and repay it when business picks up.
Key Differences Between Term Loan and Revolving Credit
To enhance the key differences, here’s a more precise table that showcases how each option works in specific scenarios:
| Feature | Term Loan | Revolving Credit |
| Purpose | One-time, large investments like purchasing equipment, expanding facilities, or buying vehicles. | Ongoing operational needs, cash flow management, or emergency expenses. |
| Repayment Structure | Fixed monthly payments, repaid over a set term (e.g., 5 to 10 years). | Flexible repayment based on how much is borrowed, no fixed term for repayment. |
| Interest Charges | Interest on the entire loan amount, included in monthly installments. | Interest only on the amount borrowed, not the full credit limit. |
| Access to Funds | One-time disbursement of the full loan amount at the start of the loan. | Can draw from the credit limit as needed, up to the maximum available credit. |
| Flexibility | Less flexible; businesses cannot access additional funds unless they apply for a new loan. | Highly flexible; businesses can borrow, repay, and reborrow multiple times, as long as they stay within the credit limit. |
| Ideal for | Capital expenditures, long-term projects, and investments that require large upfront funds. | Capital expenditures, long-term projects, and investments that require large upfront funds. |
Which One Should You Choose as a Business?
Scenario 1: Term Loan for Equipment Purchase
- Industry: Manufacturing
- Scenario: A medium-sized manufacturing company wanted to expand its operations by purchasing additional machinery. The upfront cost of the new equipment was RM500,000, which the company did not have available in cash.
- Solution: The company opted for a term loan, which provided them the full RM500,000 needed for the purchase. With fixed monthly repayments over five years, the business could budget the payments into their cash flow planning and benefit from the immediate use of the new machinery.
- Outcome: The company successfully expanded production, and the increased revenue generated by the new machinery enabled them to comfortably meet the loan repayments while continuing to grow their business.
Scenario 2: Revolving Credit for Cash Flow Management
- Industry: Retail
- Scenario: A retail company experiences seasonal fluctuations in sales, with high revenue during festive periods but slower sales for the rest of the year. The company needed to ensure it could cover payroll and other operational expenses during low-revenue months.
- Solution: The business secured a revolving credit line of RM200,000, which they could access when needed. During slow months, the company drew RM80,000 to cover operational costs. Once revenue picked up, they repaid the borrowed amount, ready to use the credit again in the next slow period.
- Outcome: The revolving credit allowed the retail business to maintain consistent cash flow and meet financial obligations even during off-peak seasons without the pressure of large, fixed monthly payments.
How to Choose Between Term Loan and Revolving Credit
When deciding between a term loan and revolving credit, it’s crucial to consider your business’s financial needs, the nature of the expenses, and the flexibility of repayment.
When to Choose a Term Loan:
- Capital Expenditures: If your business needs a large sum of money for a specific one-time investment, such as buying equipment, opening new premises, or acquiring a business vehicle, a term loan is often the best choice. The fixed repayment schedule makes it easier to plan and budget for the repayment over time.
- Predictable Cash Flow: If your business has a stable and predictable cash flow, a term loan’s fixed repayment schedule won’t disrupt your cash flow planning. You’ll know exactly how much to set aside each month.
- Building Business Credit: Term loans are also a great option for building your business credit. Consistently making payments on time will enhance your creditworthiness, potentially allowing you to access more favorable financing options in the future.
When to Choose Revolving Credit:
- Operational Expenses: Revolving credit is an ideal choice for covering ongoing operational expenses. For example, if you need extra funds to cover payroll, rent, or inventory, revolving credit gives you the flexibility to access the funds when needed.
- Fluctuating Revenue Streams: Businesses with seasonal revenue or unpredictable cash flow (e.g., retail or tourism industries) benefit from the flexibility of revolving credit. You can borrow and repay as needed without committing to fixed monthly payments.
- Short-Term Cash Flow Management: If your business needs a temporary boost to cover an unexpected expense or a brief cash flow gap, revolving credit provides immediate access to capital.
Conclusion
Both term loans and revolving credit have unique advantages, and choosing the right one for your business depends on your specific financial situation and goals.
- Term loans offer structured, fixed repayments over a set period, making them perfect for larger, one-time investments like purchasing equipment or expanding your business.
- Revolving credit, meanwhile, provides flexibility for short-term and operational needs, allowing you to draw on funds as required and repay as your cash flow allows.
Before making a decision, assess your business’s cash flow, financial needs, and growth projections. Consider consulting with your financial advisor or lender to find the best solution that fits your business goals.
