Short-term finance: what to use and when to use it

Short-term finance can be useful when your business has a temporary cash gap. The key word is temporary.

For many London SMEs, cash flow pressure doesn't always mean the business is struggling.

A café may need extra stock before a bank holiday rush. Or, a retailer may need to pay suppliers before peak trading.

That's where short-term finance can help. Used carefully, it gives you breathing room. Used without a plan, it can become expensive.

What is short-term finance?

Short-term finance is borrowing designed to cover a short-term need, usually over weeks or months.

It's often used to support working capital, which means the money your business needs to keep running day to day.

That includes:

• Wages.

• Rent.

• Tax bills.

• Supplier payments.

• Stock costs.

• Other regular outgoings.

A business can be profitable on paper and still have cash flow problems. That often happens when money leaves the business before money comes in.

You may have confirmed sales, signed contracts or regular customers. But if the cash hasn't landed yet, you still need to cover the gap.

London businesses can feel this sharply because rent, wages, travel, storage, utilities and supplier costs can all put pressure on the bank balance.

Short-term finance can help you:

• Buy stock before a busy period.

• Cover payroll while invoices are being paid.

• Deal with an unexpected repair.

• Pay a supplier deposit for a confirmed order.

• Manage a quiet trading month.

The important test is whether the borrowing helps solve a timing issue, rather than covering a deeper problem in the business.

Types of short-term finance

Which type you choose will depend on why you need the money, how quickly you can repay it and how predictable your income is.

Business overdraft

This lets you borrow through your business bank account up to an agreed limit.

It can work well for small, short-lived gaps, such as waiting a few days for a customer payment.

The benefit is flexibility, but overdrafts can be expensive, and your bank can reduce or withdraw the facility.

Short-term business loan

This gives you a fixed amount of money that you repay over an agreed period, usually with interest.

It can suit a clear, one-off need, such as buying equipment for a confirmed contract or stock for a predictable sales period.

You know how much you're borrowing and when repayments are due, but repayments start whether your sales arrive as expected or not.

Business credit card

This can help with smaller purchases, travel costs, subscriptions or emergency spending.

It can be useful if you repay the balance in full each month. It becomes risky when you carry debt from month to month, because interest and fees can build quickly.

Line of credit

This gives your business access to an agreed pot of money. You draw down what you need and usually pay interest on what you use.

It can suit businesses with irregular income, such as agencies or wholesalers, where costs come in waves rather than evenly each month.

Invoice finance

This lets you access money that's tied up in unpaid invoices.

Instead of waiting 30, 60 or 90 days for a customer to pay, a finance provider advances some of the invoice value upfront.

It can be useful for B2B businesses that have reliable customers but slow payment terms. The downside is cost, and there may be conditions around which invoices qualify.

Merchant cash advance

This is funding you repay through a percentage of your card sales, which means repayments rise and fall with card income.

It can appeal to cafés, salons, restaurants, shops and hospitality businesses that take regular card payments.

The main thing to understand is the total cost, as this type of finance can be harder to compare with a standard loan.

Common short-term finance lenders and providers

London SMEs can access short-term finance from high-street banks, challenger banks, online lenders, specialist finance providers and brokers.

High-street banks are often the first place to look. Online lenders may offer faster decisions, though their costs can vary.

Brokers can help you compare options, but make sure you know what fees they charge.

Before choosing a lender, check:

• The total amount you'll repay.

• The interest rate or factor rate.

• On what dates you'll make repayments.

• What arrangement fees and late payment fees will apply.

• Whether you need to provide a personal guarantee – this is when you personally agree to repay the debt if the business can't.

When short-term finance can be helpful

Short-term finance works best when there's a clear reason for borrowing and a clear route to paying the money back.

It can help when cash is uneven but the business fundamentals are sound.

For example, you may have confirmed orders, a reliable sales pipeline or invoices waiting to be paid. In that situation, short-term finance can help bridge the timing gap.

It can also help you act quickly. A supplier might offer a discount for buying stock in bulk, or a piece of equipment might break before your busiest month.

In these cases, borrowing can protect sales or help you take an opportunity that has a realistic return.

But you must plan well.

Borrowing £10,000 to win £30,000 of confirmed work may make sense if the margins are strong and payment dates are clear. Borrowing £10,000 because "things should pick up soon" is much riskier.

When not to use short-term finance

There are times when borrowing will only push the problem further down the road.

Be cautious if you're using new borrowing to repay old borrowing. That can turn into loan stacking, where several short-term debts build up at once.

Each repayment may look manageable on its own, but together they can drain the business.

You should also pause if you can't explain how you'll repay the money.

Hope isn't a repayment plan. If the answer depends on uncertain sales, late customers suddenly paying or a quiet month turning busy, you need to look again.

Short-term finance may not be right if:

• You're already missing regular payments.

• Your margins are too thin to absorb extra costs.

• You don't know your monthly cash position.

• You're borrowing to cover ongoing losses.

• You feel rushed into signing.

Costs, risks and preparation

The headline figure is rarely enough.

• A loan might look affordable because the monthly repayment is low, but the total cost may be high.

• A cash advance might feel manageable because repayments are tied to sales, but the amount deducted from daily takings may create fresh pressure.

• A credit card may seem convenient until interest starts building.

Before you apply, work out the full cost in plain numbers.

• How much will you receive?

• How much will you repay in total?

• When will each repayment leave your account?

• What fees apply?

• What happens if you repay early or miss a payment?

Then test it against your cash flow forecast.

A cash flow forecast is simply a month-by-month view of money coming in and going out. It doesn't need to be perfect, but it should be honest.

Build in VAT, PAYE, rent, insurance, software, loan repayments, stock, staff costs and subscriptions. Many businesses get caught out because they forecast sales but underestimate the timing of bills.

Lenders will usually want to understand your business, your income and your ability to repay. Before applying, gather:

• Recent bank statements.

• Bookkeeping records.

• Details of existing borrowing.

• Sales forecasts.

• Reports of unpaid invoices.

• Tax liabilities.

• A clear explanation of what the funding is for.

You should also know how much you need. Don't borrow too little and end up applying again a month later. But don't borrow more than you can sensibly repay.

A useful question is: what changes after I take this finance?

If the answer is that you can complete a profitable order or cover a known timing gap, that's stronger than borrowing just to breathe for another few weeks.

Building better habits around cash flow

Short-term finance should sit alongside better cash flow management, not replace it.

Set clear payment terms, invoice promptly and chase late payments early. For bigger projects, ask for deposits or staged payments rather than waiting until the end.

Keep a simple weekly cash check. Look at what's in the bank, what's due in and out and what might slip. If you run a seasonal business, plan around the whole year.

Read more

• Grow London Local Money – explore funding options and build strong financial foundations for your small business

• Understanding debt finance for small businesses

• WEBINAR: How to fund your business: a guide to capital for SMEs

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