Is a Small Business Loan an Installment Loan or Revolving Credit?

Business Line of Credit | Business Loans | small Business financing | Small Business Loans

Is a Small Business Loan an Installment Loan or Revolving Credit?

Ezra Cabrera | July 25, 2024

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When you’re thinking about a small business loan, you might ask yourself: Is it like a one-time payment plan or more like a credit card?A business loan for small companies can actually be either.With an installment loan, you get a lump sum of money and pay it back over time in fixed amounts—great for big, planned expenses.On the other hand, revolving lines of credit works more like a credit card, giving you flexible access to funds up to a set limit, perfect for handling everyday expenses and surprises.This article will break down the differences and help you figure out which option is best for your business.

Key Takeaways

A business loan for small companies come in two primary forms: installment loans and revolving credit. Installment loans provide a fixed sum repaid over a set period, while revolving credit offers ongoing access to funds up to a credit limit.Installment loans are ideal for significant, planned investments like equipment or real estate, offering predictable monthly payments and fixed interest rates. However, they lack flexibility and may require collateral.Revolving credit, including business line of credit and credit cards, offers flexibility for managing operational costs and unexpected expenses, but typically comes with higher interest rates and the risk of overuse leading to debt cycles.

What is a Small Business Loan?

Small business loans serve as financial aids that enable businesses to fill cash flow gaps, handle operational costs, or finance marketing campaigns.They cater to a wide range of financing needs, spanning from long-term investments in commercial real estate to short-term resolutions for immediate cash flow problems.Essentially, a small business loan can be categorized into two primary types: installment loans and revolving credit.The loan amounts for a business loan can vary significantly, ranging from as little as $1,000 to as much as $5 million.Financial institutions such as Small Business Administration (SBA), banks, credit unions, and online lenders offer these loans to small business owners, providing them with the necessary capital to grow and sustain their enterprises.

Types of Small Business Loans

Before getting a business loan, it’s crucial for the business owner to know the options available. Several types of small business loans are available, each fashioned to meet specific business requirements. A term loan and small business line of credit are among the most common options.Term loans, also known as small business installment loans, provide a fixed amount of capital that is repaid over a predetermined period with regular payments.These loans are ideal for large, planned investments such as purchasing equipment or expanding business operations.Conversely, a business line of credit provides a flexible financial solution for businesses. They come with set limits and draw periods, allowing businesses to borrow, repay, and borrow again as needed.This type of revolving credit can be used as working capital to pay for operational expenses or manage cash flow fluctuations.SBA loans, backed by the U.S. Small Business Administration, can also be either installment or revolving, providing competitive rates but often requiring a lengthy application process.Other types of small business loans include:Equipment financing loans, which are secured by the equipment being purchased and tend to have lower interest ratesMerchant cash advances, which offer quick funding based on credit card sales but come with high feesInvoice factoring, where businesses sell their invoices to a lender at a portion of their value to bridge cash flow gaps.

What is an Installment Loan?

An installment loan provides a single lump sum of funding that is repaid over a set period through regular monthly payments. These loans can be secured, requiring collateral, or unsecured, relying on the borrower’s credit score, income, and debt.The repayment schedule for an installment business loan is fixed, including the timely payments of both principal and interest, with a set end date.Installment loans are frequently used by small businesses for hefty one-time expenses like equipment purchase, business expansion, or significant investments.The predictability of fixed monthly payments helps in managing budgets more effectively, making installment loans a preferred choice for planned, large-scale investments. 

Benefits of A Business Installment Loan

One of the primary benefits of a small business installment loan, is the predictability they offer. Here are some reasons why:Fixed monthly payments make budgeting easierThey allow businesses to plan their finances with confidenceThis consistent payment structure helps manage monthly budgets more effectivelyIt reduces the risk of unexpected financial strainA business installment loan offers several advantages for companies:Access to larger sums of money, which is crucial for significant investments or business expansionsPredictable repayment schedules and fixed interest rates, protecting businesses from fluctuations in interest ratesStability for businesses looking to make substantial investments without the worry of variable interest ratesThese advantages make business installment loans particularly useful for large, planned investments.Furthermore, installment loans typically have longer repayment terms, which can result in lower monthly payments spread over a more extended period.While this might increase the total interest paid over the life of the loan, it provides the borrower with manageable, predictable payments that can be planned for in advance.

Drawbacks of Installment Loans

Despite their advantages, installment loans come with certain disadvantages. One significant disadvantage is their rigid repayment structure.Unlike revolving credit, which allows for flexibility, installment loans require the same payment amount each month, which can be challenging for businesses with unpredictable cash flows.Some other disadvantages of installment loans include:High interest ratesLonger repayment termsPotential for prepayment penaltiesLimited borrowing optionsIt’s important to carefully consider these disadvantages before deciding to take out an installment loan.Many installment loans have several disadvantages, including:The requirement of collateral, which puts a business’s assets at risk if they fail to meet the repayment termsMissed payments can significantly harm a borrower’s credit history, making it more difficult to secure future loans or creditLack of flexibility in repayment termsPotential prepayment penalties if the borrower decides to pay off the loan earlyThese factors should be considered before taking out an installment loan.

How Installment Loans Work in Practice

Consider a small business looking to purchase new equipment to expand its operations. By securing a business installment loan, the business can obtain the necessary funds to make the purchase without depleting its working capital. The business then repays the loan over a set term with fixed monthly payments, allowing it to manage its budget and plan for future expenses confidently.

What is Revolving Credit?

Revolving credit provides ongoing access to funds within a predetermined credit limit, allowing businesses to borrow as needed and repay to replenish the credit.This type of financing is particularly useful for managing day-to-day operational costs or unexpected expenses.Common forms of revolving credit include business lines of credit and business credit cards. Another example is SBA lines of credit.With revolving credit, businesses can enjoy the following benefits:Only paying interest on the amount borrowed, making it a flexible option for managing cash flow fluctuationsThe option to choose between secured revolving credit, which requires collateral, or unsecured revolving credit, with no collateral requiredThe ability to manage varying expenses without the rigidity of fixed monthly paymentsThis flexibility makes revolving credit an attractive option for small businesses, as they can also benefit from revolving loans.

Benefits of Revolving Credit

Flexibility stands out as the main advantage of revolving credit. Businesses can draw funds as needed, repay them, and borrow again, making it an ideal solution for short-term financing needs and cash flow management.This flexibility allows businesses to handle unexpected expenses or take advantage of immediate business opportunities without undergoing a lengthy loan application process.Another advantage is that businesses only pay interest on the funds they actually use, rather than the entire credit limit. This can result in significant cost savings compared to traditional loans, where interest is calculated on the total loan amount.In addition, revolving credit can help businesses navigate periods of fluctuating expenses or unexpected costs, providing a safety net for operational continuity.Revolving credit is useful for:Managing ongoing operational costs due to its flexible repayment termsBusinesses with seasonal fluctuations in revenue, allowing them to access funds during slow periods and repay them when business picks upMaintaining smooth operations and seizing growth opportunities as they arise

Disadvantages of Revolving Credit

Just like any other small business loan, an evolving line of credit has its own set of disadvantages. One major disadvantage is the typically higher interest rates compared to installment loans. This is due to the flexible and ongoing nature of revolving credit, which can make it more expensive over time.There is also a risk of overuse, as businesses might be tempted to rely heavily on revolving credit, leading to a cycle of debt. High credit utilization rates can negatively impact a business’s credit score, making it more difficult to secure future financing.On top of that, a revolving line of credit often involves variable interest rates, which can fluctuate and make financial planning more challenging. Some potential risks of using revolving credit include:Overuse and reliance on credit, leading to a cycle of debtNegative impact on credit scoreDifficulty securing future financingFluctuating interest rates, making financial planning more challengingIt is important for businesses to carefully consider these risks before utilizing revolving credit.

How Revolving Credit Works in Practice

A small business might use a revolving line of credit to manage seasonal fluctuations by providing funds when sales are low and replenishing the credit line when business picks up.For example, a business could use revolving credit to cover payroll during slow seasons, ensuring they can meet their financial obligations even when revenue is down.A revolving credit line can be used for:Purchasing inventory during periods of higher demand, allowing businesses to restock quickly without waiting for cash flow from salesTaking advantage of immediate business opportunitiesManaging unexpected expenses, such as emergency repairs or urgent purchases, without disrupting cash flowThis flexibility makes revolving credit a valuable tool for businesses.

Comparing Installment Loans and Revolving Credit

Installment loans and revolving credit come with distinct benefits and shortcomings, making each of them suitable for different business requirements.Installment loans provide a lump sum of money that must be repaid over a set term with fixed monthly payments, making them ideal for large, planned investments.In contrast, revolving credit offers a credit limit that can be repeatedly borrowed against and repaid, providing flexibility for managing operational costs and unexpected expenses.The key differences between these two types of financing include payment structures, interest rates, and flexibility.While installment loans offer predictability and stability, revolving credit provides ongoing access to funds and adaptable repayment terms.Understanding these differences is crucial for choosing the right financing option for your business.

Payment Structures

Installment loans have the following benefits:

Fixed payment amounts that include both principal and interest, which are paid at regular intervals

Predictability that helps businesses manage their budgets more effectively and plan for future expenses with confidence

Consistent payment structure that makes budgeting easier and reduces the risk of unexpected financial strain.

Revolving credit, on the other hand, involves variable monthly payment structures depending on the amount borrowed and repaid. Payments can fluctuate based on credit limit usage, which can lead to variable monthly costs. This flexibility allows businesses to manage cash flow fluctuations more effectively, making payments more manageable due to only paying interest on the funds used.

Interest Rates

Interest rates are another critical difference between installment loans and revolving credit. Installment loan interest rate is calculated on the total loan amount, typically offering lower interest rates compared to revolving credit. This makes installment loans less costly over the long term.
Revolving credit often carries higher interest rates due to its flexible and ongoing nature.
Credit cards and lines of credit, common forms of revolving credit, can have interest rates significantly higher than those of installment loans. This can make revolving credit more expensive, especially if balances are not paid off quickly.

Flexibility and Renewability

Revolving credit offers high flexibility and the ability to renew, allowing businesses to:

Draw funds as needed without reapplying for new loans each time

Have ongoing access to funds

Manage cash flow fluctuations

Cover unexpected expenses

This makes revolving credit particularly useful for businesses, especially when using a business credit card.
In contrast, installment loans:

Provide a fixed amount that cannot be borrowed again once repaid

Are not renewable and come with a fixed term that cannot be extended

Are suitable for large, planned investments but less adaptable to changing financial needs.

Choosing the Right Business Financing Options For Your Company

Selecting the right financing option for your business hinges on several factors, including your financial situation, loan purpose, and cash flow needs.Understanding the differences between installment loans and revolving credit can enable small business owners to make informed decisions that coincide with their particular needs.There is no one-size-fits-all answer; the key is to evaluate your business’s unique circumstances and financial goals.Key steps in this decision-making process include assessing your financial health, identifying the exact purpose of the loan, and evaluating your cash flow requirements.By carefully considering these factors, you can identify the most suitable financing solution to support your business’s growth and stability.

Assessing Your Financial Situation

Evaluating your business’s financial health is the first step in choosing the right loan. This involves understanding your revenue, profitability, and existing debt-to-income ratios.
Reviewing your business’s credit score is also vital, as it can influence your eligibility for different loan products.
For small business owners with bad credit, exploring both installment loans and revolving credit options may be beneficial to determine which best suits their needs.
A comprehensive evaluation of factors like your financial history, credit score, and revenue forecasts can help ascertain which loan type is more sustainable for your business.
A clear understanding of these elements can guide you in choosing a financing option that aligns with your business’s financial capabilities and growth plans.

Determining Loan Purpose

The purpose of the loan is a critical factor in deciding between installment loans and revolving credit. For one-time, large expenses such as purchasing equipment or real estate, an installment loan is often more appropriate. Installment loans are well-suited for specific, clear objectives that require substantial funding.
Revolving credit is better suited for:

Managing ongoing operational costs

Short-term financing needs

Covering gaps in cash flow

Handling unexpected expenses

Managing seasonal fluctuations

By defining the loan’s objective, you can ensure that the borrowed funds are directed toward their intended purpose and used efficiently.

Evaluating Cash Flow Needs

Analyzing your business’s cash flow trends is key to deciding whether the predictability of installment loan payments or the adaptability of revolving credit is more advantageous. Understanding the timing of revenue streams and evaluating your debt service coverage ratio (DSCR) can provide insights into your ability to repay a full installment or revolving loan.
A higher DSCR indicates stronger repayment capacity, which is crucial for maintaining financial stability.

The Verdict: Is a Small Business Loan An Installment Loan or Revolving Credit?

In the end, small business loans can take the form of either installment or business term loans, or revolving credit, depending on the business’s specific needs and circumstances. Term loans, a type of installment loan, are typically used for large, one-time expenses, while lines of credit, a form of revolving credit, are often utilized for ongoing operational costs.The decision between an installment loan and revolving credit should be based on factors such as the loan purpose, repayment terms, and cash flow requirements. Installment loans offer a lump sum and come with a predetermined repayment schedule, making them great for planned investments where you can expect predictable payments.In contrast, revolving credit offers flexibility and ongoing access to funds, best suited for managing fluctuating, ongoing expenses, and short-term needs.Understanding the differences between installment loans and revolving credit is essential for small business owners seeking to make informed financial decisions. By carefully assessing your financial situation, determining the purpose of the loan, and evaluating your cash flow needs, you can choose the financing option that best supports your business’s growth and ensures the long-term success of your business.

Common Questions. Straight Answers.

What are the pros of lines of credit for small businesses?

Lines of credit for small businesses offer flexibility, fast access to funds, ability to manage seasonality, and potential for lower operating costs, making them a valuable financial tool.

What are the cons of lines of credit for small businesses?

Lines of credit for small businesses can have cons such as variable interest rates, credit limits, risk of overuse, and renewal requirements. It’s important to weigh these factors carefully before making a decision.

When is an installment loan a good option for a small business?

An installment loan is a good option for a small business when it has clear, specific objectives that require financing, such as expanding into new markets or purchasing equipment. It allows for structured payments over time, making it easier to manage.

When is a line of credit a good option for a small business?

A line of credit is a good option for a small business when it needs to manage day-to-day operational expenses, cover gaps in cash flow, address emergencies, take advantage of opportunities, or have flexible financing. It provides the necessary flexibility to meet various business needs and is a valuable financial tool.

What are the two types of small business loans mentioned in the text?

The two types of small business loans mentioned in the text are installment loans and revolving credit. Both can provide different financing options for your business.

About the Author

Ezra Cabrera

Ezra Neiel Cabrera has a bachelor’s degree in Business Administration with a major in Entrepreneurial Marketing. Over the last 3 years, she has been writing business-centric articles to help small business owners grow and expand. Ezra mainly writes for SMB Compass, but you can find some of her work in All Business, Small Biz Daily, LaunchHouse, Marketing2Business, and Clutch, among others. When she’s not writing, you’ll find her in bed eating cookies and binge-watching Netflix.

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