Pros and Cons of Short-Term Financing for SMBs - Understanding the types of financing and which one is best for your business

Understanding short-term financing for SMBs

Small and medium-sized businesses (SMBs) often face cash flow challenges that require quick financial solutions. Short-term financing provides immediate access to funds, typically with repayment periods of less than a year. However, while it can be a lifeline for businesses in need, it also comes with risks. In this guide, we'll explore the advantages, disadvantages, and alternatives to short-term financing to help SMBs make informed financial decisions.

What is short-term financing?

Short-term financing refers to various funding solutions designed to help businesses cover immediate expenses. These include:

• Business lines of credit – A revolving credit option providing flexible access to funds.

• Short-term loans – Lump sum funding with a fixed repayment period, typically under a year.

• Merchant Cash Advances (MCAs) – Financing based on future sales revenue.

• Invoice financing – Unlocking cash from unpaid invoices.

• Trade credit – Deferred payments to suppliers for goods or services.

These financing options serve as critical tools for businesses managing fluctuations in revenue, unexpected costs, or growth opportunities.

Benefits of short-term financing

Quick access to funds

Short-term loans and other financing options offer fast approval processes, making them ideal for covering urgent expenses such as payroll, inventory purchases, or equipment repairs.

Flexibility in use

Businesses can use short-term financing for various needs, including bridging seasonal revenue gaps, funding growth opportunities, or managing unexpected expenses.

Easier qualification process

Unlike traditional long-term loans, many short-term financing options have simplified eligibility requirements, making them accessible to SMBs with limited credit history.

Helps build credit

Successfully repaying short-term financing can help businesses strengthen their credit profiles, increasing their chances of securing better financing terms in the future.

Supports business growth

Short-term loans can be used strategically to invest in marketing campaigns, product launches, or new equipment purchases, leading to growth without long-term debt commitments.

Risks and disadvantages of short-term financing

Higher interest rates

Short-term financing often comes with higher interest rates compared to long-term loans, increasing the overall cost of borrowing. SMBs must carefully calculate the total repayment amount to ensure affordability.

Shorter repayment periods

SMBs need to repay borrowed funds quickly, which can create cash flow pressure if revenue does not align with repayment schedules.

Possible hidden fees

Some traditional short-term financing options, especially merchant cash advances and invoice factoring, may include origination fees, late penalties, or early repayment fees that increase the cost of borrowing.

Types of short-term financing

There are several types of short-term financing that businesses can consider:

1. Trade credit

Trade credit is a widely used form of short-term financing. It involves buying goods or services from a vendor today and deferring payment to a later date, typically within days or weeks. This arrangement allows businesses to acquire necessary resources without immediate cash outflow, providing them with flexibility in managing their finances. However, suppliers won’t just hand out trade credit to anyone–business owners must earn their trust first. When in doubt, think of Wimpy’s famous line from the Popeye the Sailor Man cartoon: “I’ll gladly pay you Tuesday for a hamburger today.”

2. Short-term loans

Short-term loans are another popular option for businesses to meet their immediate funding needs. These loans are provided as a lump-sum payment by financial institutions for a specific period, usually repaid within 12 months. Short-term loans may or may not require collateral, such as a vehicle or piece of real estate. They offer businesses relatively quick access to capital (compared to long-term loans), enabling them to address urgent financial needs or invest in short-term projects.

3. Line of credit

A line of credit is a flexible financing option that allows businesses to borrow funds up to a predetermined limit. Unlike traditional loans, interest is charged only on the amount used, similar to a credit card. This form of short-term financing provides businesses with a safety net, ensuring they have access to funds on demand, without incurring unnecessary interest expenses.

4. Invoice financing

Invoice financing, also known as accounts receivable financing, is a specialized form of short-term financing. It involves selling outstanding invoices to a lender in exchange for immediate cash, usually a percentage of the invoice value. This option helps businesses improve their cash flow by converting their accounts receivable into immediate working capital. However, before going this route, it’s important to let customers know that a third party might be communicating with them so there are no surprises. 

5. Merchant Cash Advance:

Merchant cash advances (MCAs) offer businesses a quick and unique funding solution. By providing a lump sum of capital up front in exchange for a percentage of daily credit card sales, MCAs cater to immediate financial needs. Unlike traditional loans, payments are seamlessly aligned with daily cash flows, granting businesses flexibility. Here's how Pipe Capital is using an MCA structure to give small businesses more capital access.

Each type of short-term financing has its own advantages and considerations. Businesses should carefully evaluate their unique needs and financial situation to determine the best option.

When to use short-term financing

Short-term financing is best suited for businesses in the following situations:

• Covering Seasonal Cash Flow Gaps – Businesses experiencing fluctuations in revenue, such as retail stores and tourism-based businesses, can use short-term financing to maintain operations.

• Taking Advantage of Growth Opportunities – If a business needs quick capital to secure a large order or invest in marketing, short-term financing can provide a timely solution.

• Handling Emergency Expenses – Unexpected costs, such as equipment breakdowns or urgent repairs, can be managed with immediate access to funds.

• Bridging Invoice Payment Delays – If a business is waiting for payments from clients, invoice financing can cover short-term expenses until invoices are paid.

The takeaway

In conclusion, short-term financing can provide SMBs with the capital needed to meet immediate financial needs, considering the ebbs and flows of cash flow. However, it is essential to carefully weigh the pros and cons before opting for this financing option. As part of doing their own research, SMBs should evaluate their unique situation, assess the suitability of short-term financing, and explore alternatives to make informed financing decisions. 

Revenue advances from Pipe are one option for small business owners seeking short-term financing. Pipe’s revenue advance is based purely on the revenue and health of the business and determined through secure, live data connections, so there’s no need for lengthy applications. You only pay for what you use, with flat, transparent fees paid over time, and payments are based on revenue to sync with your business’s cash flow. If you’re considering your options, you can learn more about how Pipe works here.