What is short term credit, exactly?
If you’re considering starting your own business, we’re sure that you’ll agree with us when we say that, just like other business terms – short-term credit can often be both a point of confusion and a term that is often misunderstood.
In the eyes of the bank, short-term credit is essentially a general term that refers to a line of credit that is offered to either a business or individual for a term fixed at 12 months or less.
That being said, short credit isn’t different from long term credit; the only difference is that it expires within the “short-term” time frame.
Still, if you are thinking about taking out a short-term loan, it’s a good idea to make sure that you are well aware of what short term credit consists of, why it’s used as well as whether or not it might be an ideal option for you or your business.
So, whenever you’re ready, just keep on reading to discover more about short-term credit.
What Is Short Term Credit?
Before we get any further into this guide, we first think that it would be a great idea to outline what short-term credit is, as well as why it matters.
As we have already briefly mentioned above, short term credit essentially refers to a type of credit that is agreed upon between bank and lender to be repaid within a repayment period of fewer than 12 months.
Typically, the time frame is usually between 30 to 60 days.
Even though there is short term credit that can be used for one-time payments (which we’ll get into a little more detail later) the main purpose of short term credit is typically to act as a safety net for companies both small and large.
In order to better understand this, it is important to understand cash flow.
Generally speaking, it is normal for cash to come into businesses at different times throughout the course of the business year.
During some parts of the year, cash flow can be pretty steady, and for other parts of the year – it can be a little slower.
Due to this cycle that many businesses find themselves having to face, banks offer special, short term credit loans that are specifically designed to help aid companies with their cash flow in order to ensure that they stay on schedule with payments, sales, and more.
When a company expresses interest in lending from a bank, there will typically be a lending assessment process where the bank will assess whether or not the company is a suitable candidate for lending a loan.
To sum up, the above, short-term loans are designed to be paid off through various cash flow activities throughout the month.
What Is The Purpose Of Short Term Credit?
Now that you have a better understanding of what short term credit is, we’re sure that you might be wondering what the main purpose of this type of loan is.
Essentially, short term credit is usually used in order to meet a pressing or recurring expense, such as payroll.
For example, if a company bills weekly and is then paid around two weeks later, this will mean a class flow deficit.
That being said, a short term credit from the bank could then be used in order to cover the payroll until the outstanding invoice has been paid.
After the payment has been received, the line of credit can be paid off until it might be needed again.
As you can see from this example we have just shared, a short term credit can be used as a temporary safety net. Another example of short term credit is accounts receivable.
In this instance, a short-term loan could be used to pay for required raw materials and other stock inventory before paying off the loan after the ordered products have been shipped.
Other Reasons Short Term Credit Might Be Required
Even though the main purpose of short term credit is to act as a safety net for recurring expenses, there are a few other reasons that a small business might require short term credit – such as one-time payments.
In these instances, short-term loans are typically taken out with a fixed repayment period of fewer than 12 months.
An example of a short-term loan required for a one-off payment could be the opportunity to purchase a piece of equipment and then sell it for a profit.
The bank would then be able to potentially lend you the money required to do this with an agreement to pay it back within a short period of time.
Typically, in the instance of needing to take out a short-term loan, it is common for banks to require an agreed repayment period that typically lasts anywhere from 30 to 60 days.
Along with this, regardless of which type of bank you are with, the bank will typically always try to match the short term credit given with the needs of the credit.
If you are considering taking out a short-term loan, keep in mind that it is likely that the bank will always require you to be able to pay the short term credit down to zero and then maintain it for at least 30 days each year.
There we have it; you have made it to the end of the article.
Now that you have taken the time to read through all of the above, we hope that we have been able to assist you in understanding short term credit a little better, while also being able to understand whether or not it might be the right option for you and your small business.
Just to sum up all that we have discussed above, there are many different ways that short-term credit can be used (both personally and for a business) and this is often where the point of confusion and misunderstanding comes from regarding this particular type of lending credit.
Generally speaking, short term credit refers to a loan taken out by a company to pay off recurring payments as needed – and typically serves as a safety net.
As well as this, a short-term loan often refers to a loan that is required for a one-time payment, with an agreement to pay back the loan in less than 12 months.
While the repayment period can vary from bank to bank, the usual repayment period for these short-term loans is typically either 30 days or 60 days.
All that being said, we hope that you now have a much better understanding of what short term credit is, how it differs from long term credit, and whether taking on short term credit will be the right financial choice for you.
Thank you for reading this guide; we hope that you have found it helpful.