Top 10 loan and financing options for small businesses in Australia

Every business owner and manager is constantly thinking about financing their operations. No matter how long you’ve been in business, ensuring continuity is always a priority. Most Australian small and medium businesses are family owned and operated, and often look to external loans and funding options to help cash flow.

In this post, we’ll outline some of the financing options available to business owners. The terms and conditions of these options will vary based on your bank. If you’re considering a loan, be sure to compare the legal commitments required by each type of loan before making your selection.

Overdrafts and credit cards

These are the easiest ways to get immediate cash for your business.

Overdrafts

Duration: short-term loan

Ideal for: immediate cash for everyday expenses

I’d like to think of it as finding $10 in an old jacket pocket. It’s a great backup option you can leverage when you’re short on funds. For example, if you have $50,000 in your account and your office rent of $55,000 is auto-deducted, you would draw an overdraft of $5,000. If you have overdraft protection enabled, that $5,000 will go through without requiring additional authorisation. If your bank doesn’t have overdraft enabled automatically, and you haven't enabled it manually, you’ll receive a notification from your bank and your rental authority quoting insufficient funds.

Your bank is helping you out at a time of need, but they’ll charge interest for this service. When you overdraw from your account, your bank balance will become negative. You have to bring it back to a positive figure before a set due date or pay periodic interest. Overdraft interest is usually lower than credit card interest, mainly because you tend to draw less on your overdraft than on your credit card.

Things to consider before using your overdraft:

●  Has it been enabled automatically on your account?
●  What’s the limit on your overdraw? It differs from bank to bank, and based on how much money you have in your account.
●  What are your bank's interest rates, due dates, and terms and conditions?
●  Do you want to link your overdraft to your credit card? If you do this, it will appear on your credit score.

Credit cards

Duration: short-term loan

Ideal for: immediate cash in hand for small - medium sized expenses

This type of "loan" is usually reserved for bigger business expenses and comes with higher, often monthly, interest rates.

As with overdrafts, you’ll have a maximum amount you can spend (your credit limit) over a specific period, usually three years. How you choose to spend your credit is up to you, but it’s best to pay it back as soon as you can. If you fail to repay your debt when it's due, you may incur a penalty—apart from your interest.

Credit card conditions vary based on your usage and repayment capabilities. For instance, credit cards that offer interest-free days are a good option if you know you can repay your credit fairly quickly. If you're unsure you can pay it back on time, get a card with low interest so you're not bogged down by deadlines. Discuss your finances with your bank transparently, questioning them about interest rates and penalty rates for delayed payments.

Things to consider before getting a credit card:

●  The number of credit cards you currently have and your ability to repay.
●  Interest rates and rewards you might accrue on your card.
●  A comparative cost analysis between banks and the cost of transferring your balance to another bank, should you need to.
●  Types of fees you might have to pay during the lifetime of your credit card (such as an introductory rate, purchase rate, and annual fee), and their impact on your business cash flow.

Both overdrafts and credit cards have a low barrier to entry. This means that regardless of your business size and years of operation, you can get immediate cash for your daily activities. The more money you want to borrow, the more questions lenders will ask you.

Finance options for small businesses just starting out

Let’s look at the financing options available for small businesses and start-ups that don't have assets to use as security.

Fully drawn advance

Duration: long-term loan

Ideal for: large one-time purchases

This loan is ideal for long-term financing, which is useful when you're buying machinery or property. There’s no maximum borrowing limit and you get all the money upfront. It’s a fixed-term loan, but it’s highly customisable, so you can choose flexible repayment schedules. A fully drawn advance is extremely lucrative for smaller businesses because it can be interest-only. This means your interest will be low, but you’ll be paying a single large sum at the end of your term. This is called a balloon payment.

Things to consider before choosing a fully drawn advance:

Changes in market conditions may impact the value of the asset you intend to purchase. For example, if you have a fixed interest rate (over 30 years) and the value of the asset declines during that period, you'll be paying an interest higher than current market value. This is especially important if you’re applying for a loan now that RBA is increasing interest rates. Higher rates will reduce asset value, so at the end of the term, if you intend to sell the property to help repay your balloon payment, your property value could be significantly lower than it was when you purchased it.

Cash flow lending

Duration: short-term loan

Ideal for: immediate cash for small everyday expenses when you don't have strong assets or a history of repayment

This is an unsecured loan, ideal for expenses like refilling stock, payroll, and rent. You’re essentially borrowing from revenue and profit you'll make in the future—the cash flow of your business.

Cash flow loans are also a good option if your credit score is low or if you have outstanding credit card debts. However, because it’s an unsecured loan, you may incur higher interest rates than you would with a secured loan.

Things to consider before choosing cash flow lending:

●  Repayment conditions, such as additional costs for early closure and maintenance fees.
●  The lender's terms and conditions on interest rates. If you have a high credit score, you could be eligible for a discounted interest rate.

Trade finance

Duration: short-term loan

Ideal for: purchasing goods from overseas

This is exclusively for international trading. When you buy stock/products from an overseas supplier, your bank will pledge to pay your supplier's bank directly when the seller meets the conditions of your sale. As the buyer, with your bank's advice, you’ll create a letter of credit for your seller, outlining the terms and conditions of your agreement. Once they've shipped the products, your seller can take the letter of credit to their bank and claim their payment. This way, you don’t have to shell out a large sum of money and wait (possibly) months for your products to arrive. This loan is a good way to help maintain your cash flow.

With this loan, your bank is paying on your behalf. You still have to meet your bank's requirement criteria to be approved.

Trade finance agreements are low risk and reduce barriers of entry for international trading. They can be tailored to suit your needs, and your bank may have a broad range of products that fall under the trade finance umbrella. Talk to your provider for help selecting the right product.

Things to consider before choosing trade finance:

●  How prepared you are to trade and comply with international legal operational requirements.
●  Customs and quarantine processes for the goods you’re purchasing.
●  Whether you can still manage to run your business if there are unexpected shipping delays.

Vehicle or equipment finance

Duration: long-term loan

Ideal for: purchasing business assets

Also known as asset finance, this is another type of loan where your bank directly pays your seller. Interest rates are flexible, and the potential loan amount is determined by your credit history. If you already have a loan, and choose the same bank for your vehicle/asset finance, you may receive special benefits based on your bank’s policies. Each bank has additional requirements for this type of loan, such as a minimum period of operation or turnover.

If your business is registered for GST, you may be able to claim credit on the amount you pay as GST on your vehicle loan repayments. Along with your vehicle/asset loan, you can purchase guaranteed asset protection (GAP) insurance, which will cover the remainder of your asset’s value if you have to write it off for damages or theft. Many banks also offer additional discounts when you purchase renewable equipment, electric vehicles, and other environmentally-friendly assets.

Things to consider before choosing vehicle or asset finance:

●  Whether you’d like to buy a new or used asset, and the benefits and challenges of each.
●  If there's a local spare parts provider or repair service that caters to the brand of vehicle/equipment you purchase.
●  You may incur additional fees if you apply for more money after your loan has been approved for a specific amount.
●  You might have additional fees if you have to terminate your loan prematurely.
●  Your bank will inspect and valuate your assets before approving your loan. This could come with a one-time fee.

Leases and hire

Duration: medium/long-term loan

Ideal for: leasing, renting, or hiring assets
    
This is similar to vehicle or asset financing, however, the commitment is much smaller. You’ll pay less in fees and you can upgrade your asset at the end of your contract. For example, if you sign a three-year lease on a truck, at the end of your lease, you can choose to get another, possibly newer model. On the flip side, when you lease or hire an asset, you won’t have any ownership of it, meaning you can’t modify the vehicle/equipment unless your lessor explicitly agrees to it.

Things to consider before leasing a vehicle/asset:

●  Cost comparisons between various lenders.
●  Total cost of the lease/hire. Though small and gradual, expenses may add up over time.
●  Disparity between the type of assets available and the assets you want to obtain.

Finance options for established businesses

Businesses that have been around for a while, regardless of size, will own strong business assets. These could take the form of equipment, business premises, vehicles, or capital investment. For this reason, established businesses have more financing options than new businesses.

Line of credit

Duration: short/medium-term loan

Ideal for: projects with ongoing and uncertain expenses

Line of credit is a buffer you can fall back on when expenses exceed expectations. Unlike traditional loans that give you a bulk amount upfront, a line of credit is when a bank approves a maximum amount you can draw from. This ensures that you have continuity of cash flow for your project. For example, if you’re planning on renovating your storefront, you can get a line of credit for $100,000. This money acts the same way as your credit card—you can draw as much as you need from your $100,000, except, unlike with the credit card, you only pay interest on the amount you draw.

Line of credit loans can be secured against your existing assets or they can be unsecured. Either way, your interest rates are flexible and may depend on how much you draw. This means that over time, you may end up paying more interest than you would have with a standard fixed-term loan.  Therefore, a line of credit isn’t suitable for large, one-time purchases, like a vehicle, home, or other fixed asset. A line of credit is best suited for projects that require continuous spending without a fixed cost, like building renovations and product research and development.

Things to consider before applying for a line of credit:

●  Different banks charge different fees throughout the lifetime of your credit, including a one-time establishment fee and monthly maintenance/loan account fees on funds you haven't used.
●  Interest rates are variable, which means when RBA increases the cash rate, your interest rate may also increase.
●  Normally, interest you pay on your line of credit is tax-deductible. However, under certain conditions, such as when a line of credit is used to repay an investment loan exclusively for tax benefits, the interest may not be tax-deductible. Be sure to check with your bank and compare rates between multiple institutions before you choose a lender.

Invoice/debtor finance

Duration: short-term loan

Ideal for: quick cash in hand for everyday/unexpected expenses

Under this loan, you’ll be borrowing money against your accrued income. This is particularly useful for established businesses that may have multiple invoices owed to them. Your bank will provide most of the value of your invoices (usually 80%-85%) upfront, and the remainder when your invoices are paid. Your interest will depend on the period of your invoice. For example, if your invoices allow up to 6 months for payment, you’ll pay interest for 6 months.  

Invoice/debtor finance is a good way to get instant funds and relieve any cash flow stress you have in your business. Your bank will hold your accrued invoices as liabilities, so this type of loan is ideal for short-term needs. Invoice/debtor finance can take two forms:

●  Invoice financing: You will still manage your invoices and any related communications with your customers.
●  Invoice factoring: Your bank/lender will take ownership of your invoices, and manage all communications with your customers.

Things to consider before choosing invoice/debtor finance:

Additional costs, such as service fees and due diligence fees. Compare costs between multiple lenders before you choose a vendor.
Possible impacts on your business relationships if you choose to go with invoice factoring.
How you’ll close out your loan if your invoices are paid before the due date. You can discuss this with your lender beforehand.

Mortgage equity loan

Duration: long-term loan

Ideal for: getting a second long-term loan when you already have an ongoing loan

This is when you get a loan on the equity of an asset with an existing mortgage. For example, if you've taken out a loan on your business premises for $900,000 and you've paid off $600,000 worth of its price including interest, you'll still owe the remaining $300,000. That will be your equity—you can borrow a further $300,000 on your existing loan.

When the RBA increased its cash rate, it in turn pushed interest rates up for people paying off a home or business loan. Many individuals and businesses responded by using a mortgage equity loan to refinance their existing loan.

Things to consider before choosing a mortgage equity loan:

●  The real cost of this loan. It comes with additional fees for evaluation, establishment, and maintenance.
●  A mortgage equity loan will increase your existing debt and your repayment commitments. Make sure you’re in a stable position to manage your loan.

Fully drawn advance for larger investments

As outlined earlier in this blog, a fully drawn advance is ideal for businesses of all sizes. It’s a long-term loan, suitable for large investments such as land, property, and equipment.

Loan applications can take months, so before you dive into that process, it’s worth looking at what type of loan you want to apply for and whether you meet the requirement criteria. A good way to weigh your loan options is to consider your specific requirements and how long you’re willing to pay interest.

Wrapping up

This blog is not financial advice. As we've outlined, there are so many ways to fund your business that it can be a bit overwhelming. We support self-learning, and we hope this blog helps you with your research. However, we also recommend discussing your situation with a trusted financial advisor before deciding which loan is best for you. With cash rates set to gradually increase throughout the year, it's more important than ever to seek professional financial guidance.

Read next: Questions to ask yourself before you apply for a business loan