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If you’re looking to grow your small business, you have two main financing options to choose from: installment loans and revolving credit. Installment loans give you a lump sum of cash up front that you pay back (with interest) in monthly payments. Revolving credit, on the other hand, provides a source of funds you can draw on and repay (with interest) as needed. Each has its own features, pros, and cons to consider as you research your business financing options.

Below, you’ll find the basics about installment loans, revolving credit, and the differences between the two so you can make an informed choice about which financing option makes sense for your business.

Revolving Credit vs Installment Loans

While both types of business loans offer companies access to the funds they need, there are a few key differences to be aware of.

What Is an Installment Loan?

A business installment loan is a type of small business financing that provides a fixed amount of capital you can use to cover business expenses. You then pay back the loan in fixed monthly installments that include both principal and interest for the duration of the loan term. For example, if your company takes out a $20,000 loan with a 7.5% annual percentage rate (APR) and a five-year term, your monthly payment will be $400.76.

Within the category of business installment loans, there are both long-term business loans and short-term business loans. Both are offered by banks, credit unions, and online lenders.

Qualification requirements for installment loans will vary depending on the lender. Bank and Small Business Administration (SBA) loans tend to have higher requirements in terms of time in business and credit scores, while online lenders may rely more on your sales and revenues to determine your eligibility. If you own a startup but have bad credit, there may be loan options for your business as well.

Recommended: Guide to Business Loans for Bad Credit

Features of Installment Loans

Also known as installment debt, installment loans give you access to the working capital you need, whether it’s to expand your business or to get through a slow period. The downside to these loans is that they involve an ongoing commitment to regular payments that you’ll have to make for the duration of your loan term.

Here are some features of installment loans to consider.

You’ll Make Monthly Payments

When you sign your loan agreement, you’re agreeing to make a payment (which includes both principal and interest) each month. If you choose a fixed interest rate, the amount you pay will be the same each month. This can make it easier for you to budget that loan payment among your other monthly business costs. Most installment loans come with fixed rates.

If you opt for a variable interest rate, your interest rate can change depending on market conditions. The small business loan interest rates for variable loans typically start lower than the interest rate on a fixed business loan, but they can go up or down over time. This may make it a little more difficult to budget. However, the loan terms typically limit how much it can fluctuate from one period to the next.

Recommended: Conventional Business Loans vs SBA Loans

You’ll Get a Lump Sum

Many times, you know you need a certain amount of money to cover a business expense, such as renovating a building or purchasing costly equipment. An installment loan, unlike revolving credit, gives you access to the amount you are eligible to borrow in one lump sum. Having that working capital may allow you to take advantage of business opportunities you wouldn’t otherwise have been able to afford.

You May Get a Tax Deduction

If you’re concerned that taking out a loan would mean you have to pay more in taxes, don’t be. The money you receive as a loan doesn’t count as part of your revenue. And a potential plus is that the interest you pay on the loan may be tax deductible.

When to Use an Installment Loan

An installment loan might be good for your business if:

•  You need a lump sum up front.

•  Your small business has a relatively steady income so you can budget for regular payments.

•  Your small business is well-established and/or you have good credit, meaning you may be more likely to get good loan terms.

Recommended: Can a Personal Loan Be Used to Start a Business?

What Is Revolving Credit?

Revolving credit provides working capital or credit to cover small business expenses. It can include business lines of credit, tradelines from vendors, and business credit cards. With each one, you’re approved to use up to a set amount of credit, but you aren’t required to take it all out at once. You only pay interest on the amount you actually borrow. Once you repay the funds, they are available to borrow again.

For example, let’s say you get a line of credit of $20,000 for your small business. In the first month, you take out $10,000 but pay back $5,000 that same month. That means that you’ll make payments (including interest) on the $5,000 you still owe, and you’ll still be able to draw on the remaining $15,000.

Features of Revolving Credit

Like installment loans, revolving credit has both advantages and disadvantages. It’s important to be aware of both when you’re choosing a way to purchase what you need for your business.

You Can Access Funds When and If You Need Them

Sometimes you can’t anticipate how much cash you’ll need to cover business expenses down the road. If that’s the case for your business, it can be helpful to have access to a line of credit instead of receiving a lump sum that you immediately have to start paying back.

Funds Are Always Available (Up to Your Maximum)

With an installment loan, the account is closed once you’ve paid off your balance in full. But with revolving credit, you can take out additional funds once you’ve paid down your balance. There’s no need to reapply for more funds after you’re initially approved.

You May Have an Option to Earn Rewards

Credit cards, which are one type of revolving credit, often offer rewards and perks that may help offset what you pay in interest. If you earn points for your transactions, you may be able to redeem those points for cash back or travel rewards. And while high interest rates are a potential negative for credit cards, if you pay your balance in full each month, you won’t be hit by high interest charges.

When to Use Revolving Credit

Revolving credit might be good for your business if:

•  You want to be prepared for future financial needs but don’t require a lump sum right away.

•  You may need access to relatively small amounts quickly to take advantage of business opportunities or pay for shortfalls.

•  Your business has a need for perks offered by business credit cards. If you have to travel frequently for your company, for instance, a card that offers miles could help defray those costs.

Recommended: How Much Does It Cost to Start a Business?

Installment Loan and Revolving Credit Options

Once you’ve researched the numbers and determined how much money you want to borrow, either through an installment loan or a revolving credit line, it’s time to start shopping solutions. Here are a few options you may want to consider.

•   Traditional bank loan: This is a small business loan given by a bank or credit union. Qualification requirements are often stricter than with online business loans.

•   SBA loan: Backed by the Small Business Administration, SBA loans typically come with better rates and higher loan amounts than traditional and online business loans.

•   Business line of credit: Similar to a credit card, a business line of credit gives you a maximum amount to draw on. Once you pay it back, you can continue to use the funds up to the maximum credit limit.

•   Equipment loan: An equipment loan is a small business loan used to purchase equipment. The equipment acts as collateral, which can sometimes land you a better interest rate.

•   Merchant cash advance: A merchant cash advance allows you to receive funding in exchange for future credit and debit card sales. Merchant cash advances technically are not loans, and can be one of the most expensive forms of borrowing.

•   Business credit card: Business credit cards may be ideal for those that want to take advantage of credit card perks and rewards. Interest rates are often higher than loans, so if you go this route, you’ll want to make sure you can afford to pay your credit card in full each month.

•   Invoice factoring: Invoice factoring allows you to sell unpaid invoices to a factoring company. You get a percentage upfront, and then once the factoring company collects the payment, you get the remainder minus any fees. With invoice factoring, funding is typically fast but can be expensive.

Each option and lender will have different criteria, so do your due diligence when researching which options you will qualify for at the best rate.

Recommended: 15 Types of Business Loans to Consider

The Takeaway

Installment loans give a lump sum of cash up front that must be paid back (with interest) in monthly payments. Revolving credit, on the other hand, provides a source of funds a business owner can draw on and repay (with interest) as needed. Each has its own pros and cons.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

Is a small business loan an installment loan or revolving credit?

A small business loan is typically an installment loan, where a lump sum is provided upfront and repaid in fixed payments over a set period. However, some small business financing options, like lines of credit, function as revolving credit, allowing flexible borrowing and repayment as needed up to a limit.

What types of loans are revolving?

Business revolving loans include business lines of credit and business credit cards. These loans allow borrowers to access funds repeatedly up to a set limit, repay them, and borrow again as needed. Interest is charged only on the amount used, offering flexible borrowing and repayment terms.

Is an SBA loan considered an installment loan?

Yes, an SBA loan is considered an installment loan. Backed by the Small Business Administration, borrowers receive a lump sum upfront and repay it in fixed monthly installments over a set period. The loan terms, including interest rates and repayment periods, vary based on the specific SBA program.

Photo credit: iStock/PixelCatchers

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q324-060

Depreciation and amortization are methods for deducting the cost of business assets over a number of years, as opposed to writing off the entire cost the year you make the purchase. The concept behind both is to match the expense of acquiring an asset with the revenue it generates.

The key difference between depreciation and amortization is the type of asset being expensed: Depreciation is used for tangible (physical) assets, while amortization is used for intangible (non-physical) assets.

Read on to learn exactly how depreciation and amortization work, how these two accounting methods are similar and different, and when to choose one or the other.

Amortization vs Depreciation

Similarities

Both depreciation and amortization are accounting methods used to spread the cost of an asset over a specified period of time. With both, you are able to deduct a certain portion of the asset’s cost — and reduce your tax burden — each year for the number of years that asset is of value to your business.

In addition, both depreciation and amortization are non-cash expenses, which means they are reported on the income statement of the company, but no cash is spent.

Differences

The key difference between amortization and depreciation is that amortization is used for intangible property (meaning property you can’t pick up and hold), such as a patent or computer software program.

Depreciation, on the other hand, is used for fixed assets or tangible property (meaning assets that are physical in nature), such as computers, manufacturing equipment, and cars.

Another distinction: With depreciation, you cannot deduct the full cost of the asset. You must account for its resale value at the end of its useful life. For example, if you pay $20,000 for a piece of farming equipment and at the end of its useful life (10 years) you think you’ll be able to sell it for $5,000, then you would only deduct $15,000 over the course of 10 years.

In addition, amortization is almost always implemented using the straight-line method, whereas depreciation can be implemented using either the straight-line or an accelerated method.

Recommended: How to Read Financial Statements

What Is Amortization and How Does It Work?

Amortization is a method of spreading the cost of an intangible asset over a specific period of time, typically the course of its useful life. Intangible assets are non-physical in nature, but are nonetheless considered valuable assets to a business.

Types of intangible assets a business may have include:

•   Patents

•   Trademarks

•   Copyrights

•   Software

•   Franchise agreement

•   Licenses

•   Organizational costs

•   Costs of issuing bonds to raise capital

Amortization is typically expensed on a straight-line basis, which means that you would divide the total cost of the asset by the number of years it will provide use to the business, then deduct that amount each year.

To determine an intangible asset’s useful life, you need to consider the length of time that the asset is expected to produce benefits for the business. An intangible asset’s useful life can also be the length of the contract that allows for the use of the asset.

(Something to note: The term “amortization” is also used in a different way in relation to loans, such as the amortization of a car loan or mortgage. The loan amortization process involves making fixed payments each pay period with varying interest, depending on the balance.)

Amortization Example

How amortization works is relatively simple. Let’s say you purchase a license for $10,000 and the license will expire in 10 years. Since the license is an intangible asset, it would have no salvage value and the full cost would be amortized over that 10-year period.

Using the straight-line method of amortization, your annual amortization expense for the license will be $1,000 ($10,000/10 years), meaning the asset will decline in value by $1,000 every year and you would be able to deduct $1,000 each year on your taxes.

Recommended: Guide to Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)

What Is Depreciation and How Does It Work?

Depreciation is the process of spreading the cost of a tangible or fixed asset over a specific period of time, typically the asset’s useful life. Tangible business assets (which the IRS refers to as “property”) are high-cost physical items that are owned by a business and are expected to last more than a year. They include:

•   Buildings

•   Equipment

•   Computers

•   Office furniture

•   Vehicles

•   Machinery

Unlike intangible assets, tangible assets typically still have some value even after they are no longer of use to a business. This value is known as resale or “salvage” value. Because the IRS assumes you will sell off the asset at some point, this amount must be accounted for in the beginning.

What is the useful life of a tangible asset? You can refer to IRS Publication 946 PDF File for guidance, which provides useful life by asset type. For office furniture, for example, it’s seven years. For computers, it’s five years.

To calculate depreciation, you need to first subtract the asset’s estimated salvage value from its original cost. Using the straight-line deduction method, you would then take that number and divide it by the number of years the asset will be of use to your business. There are other methods of depreciation that accelerate the process, meaning that a larger portion of the asset’s value is expensed in the early years of the asset’s life.

Recommended: Business Cash Management, Explained

Depreciation Example

Depreciation works in a very similar way to amortization, except that you must account for salvage value. Let’s say you purchase a $3,000 computer for your company. Per the IRS, a computer has a useful life of 60 months (or five years). After five years, you determine you’ll likely be able to sell it for $500. Here are the calculations you would make:

$3,000 – $500 = $2,500

$2,500 / 5 = $500

That means that each year for five years, you would be able to deduct $500 on your taxes.

Keep in mind that after the end of the computer’s designated useful life, you can (but are not obligated to) sell that computer. Either way, you would stop deducting the item’s depreciation as a business expense.

The Takeaway

Depreciation and amortization are both methods of calculating the value of business assets over time. Amortization vs. depreciation just depends on the type of asset you have acquired for your business.

Amortization is used for intangible (non-physical) assets, while depreciation is used for tangible (physical) assets. As a business owner, you will want to calculate these expense amounts in order to use them as a tax deduction and reduce your business’s tax liability.

If you’re in the market to purchase an asset (tangible or intangible) for your company but don’t want to deplete your cash reserves, you may want to explore funding options, such as a small business loan, equipment financing, or inventory financing.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

Do buildings depreciate or amortize

Buildings are fixed assets, so they depreciate. Depreciation is used for physical assets like buildings to account for their wear and tear over time.

Can an asset amortize and depreciate at the same time?

No, an asset cannot amortize and depreciate at the same time. Amortization is used to spread out the cost of an intangible asset over time, while depreciation is used to spread out the cost of a tangible asset over time. An asset is either tangible or intangible — it can’t be both.

Is rent considered amortization?

No, paying rent is an operating expense for your business. If you own a rental property, however, you can use depreciation to spread the cost of buying or improving the property across the useful life of the property.

Photo credit: iStock/Pinkypills

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

SOSMB-Q324-059

Incorporating your business as an LLC is a good idea for a number of reasons, not just obtaining a loan. In addition to helping you qualify for a business loan, an LLC helps protect your personal liabilities, maximize your write-offs, and more.

Keep reading to find out what an LLC is, pros and cons of forming an LLC, what type of LLC small business loans are available, and how to improve your chances of getting approved.

What Is a Limited Liability Company (LLC)?

A limited liability company (or LLC for short) is a popular option when choosing a business structure. Essentially, an LLC is a separate legal entity from you that’s created under state law. It has its own assets, liabilities, bank accounts, and credit profile separate from yours.

An LLC can have one or more owners, and each owner is called a “member.” Even if you’re just a one-person operation, however, you may still wish to opt for this business structure.

Unlike a sole proprietorship (which is owned by one person with no distinction between the business and the owner), the members of an LLC have liability protection from the debts and obligations of the business. That means a business creditor or someone who sues the business can’t come after the personal assets of the owners. Like a sole proprietorship, however, the owner of an LLC pays taxes as an individual (not as a corporation).

To form an LLC, you choose a name and file articles of organization with your state’s corporate filing office, often the Secretary of State. And, if an LLC has more than one member, it must obtain its own IRS Employer Identification Number (EIN).

Recommended: Sole Proprietorship vs LLC: How to Choose

Pros and Cons of Forming an LLC

Here are some of the pluses and minuses of forming an LLC.

Forming an LLC provides many advantages to small business owners. One of the biggest is that it can reduce your personal liability to debts incurred by the LLC. This liability protection comes without the work and expense of forming a corporation.

There are also some tax advantages. An LLC has pass-through taxation, meaning it does not pay corporate taxes on profits. Business profits pass through to the members, who pay personal income taxes on salary and other distributions received from the LLC.

On the downside, LLCs do not issue stock, which can be a powerful tool when raising capital. And, LLCs typically face higher annual fees than corporations. Some states also require annual reports in order to keep an LLC in good standing.

Another potential negative is that if a member joins or leaves an existing LLC, that LLC may be obligated to dissolve and reform with new membership.

How the Small Business Loan Process Is Different for LLCs

LLCs follow the same loan application process as other types of businesses. The major difference is who holds liability for the loan funds in case the borrower defaults.

With an LLC, the company owners are not personally responsible for the loan funds unless they sign a personal guarantee . In order to avoid having to sign a personal guarantee, your company typically needs to have an established financial track record or have some type of business assets to use as collateral to secure the loan.

What Is an LLC Loan?

An LLC loan is no different than any other type of small business loan, except it is given to the LLC and not the individual. As stated above, the business owners themselves are not liable for the loan unless they sign a personal guarantee. Instead, it is the business itself that is liable.

How Do LLC Loans Work?

An LLC loan works just like any other small business loan, since essentially that is what it is. The type of loan you choose will determine how the loan works. A business line of credit, for example, works similarly to a credit card. You are given a maximum limit of funds to which you can draw on. You make payments and pay interest only on the amount you spend.

A business term loan, on the other hand, is a lump sum of money given to you. The interest rate is usually fixed, allowing your monthly payments to stay the same until the loan is paid back.

What Expenses Are LLC Loans Used For?

LLC loans can be used for any type of business expense, including paying for working capital, hiring new employees, purchasing inventory, expanding your business, paying marketing expenses, launching a new business, refinancing existing debt, and more. Small business loans are not allowed to be used for personal expenses.

Recommended: Consolidate Business Loans

Types of LLC Business Loans

When exploring business loans for your LLC, here are some lending options you may want to consider.

Bank Loans

Banks will offer some of the most ideal loan amounts, terms, and interest rates. However, getting a business loan for an LLC from a bank generally requires strong financials and a good credit score. You also typically need to submit a fair amount of documentation in order to complete your application. If you’re looking for fast financing, a bank loan may not be the way to go.

Unsecured Loans

If your LLC is short on valuable assets or you would prefer not to put assets down as security on loans, an unsecured business loan may be a good option since they don’t require any collateral to qualify. However, since the risk is higher on the lender’s part, interest rates for unsecured business loans are typically higher than secured loans.

Online Term Loans

Online term loans generally have more flexible requirements than bank loans — meaning new LLCs, and even those with bad credit — may be able to qualify. In addition, the application process is typically quick and funding time can be fast. However, the ease and flexibility come at a cost — online business term loans tend to have higher interest rates and fees than traditional bank loans.

SBA Loans

LLCs are eligible to apply for SBA loans, which are offered by private lenders but backed by the U.S. Small Business Administration. Because this backing reduces risk for the lender, SBA loans offer LLCs some of the best interest rates, loan amounts, and repayment terms out there. However, SBA loans also have tougher qualification criteria when compared with other types of LLC business loans. And, the application and approval process can take months to complete.

Invoice Factoring

If your LLC processes a large amount of client invoices, another option to consider is invoice factoring. With this type of financing, the factoring lender pays you a percentage of your outstanding invoices up front. Once an invoice is paid, you’re given the remaining balance after a fee is subtracted for the lender. This type of financing can offer quick cash. However, fees can be hefty and the factoring company may take over communication with your customers.

Line of Credit

A business line of credit works differently than a traditional term loan. Rather than receiving a lump sum of money, a business line of credit gives you access to a pool of funds that you can draw from when you need funding. You only pay interest on the funds you draw.

Once you’ve repaid what you’ve borrowed, your line of credit will typically reset to the original amount. This can be a good way to iron out seasonal cash flow issues and keep you prepared for unexpected expenses.

Merchant Cash Advance

If you need cash quickly and your LLC processes debit and credit card payments from customers, you might consider a merchant cash advance instead of a loan. With this option, you get a lump sum of money upfront from the lender. The lender then takes a percentage of your business’s future credit and debit card sales until the borrowed amount, plus a fee, is repaid. This type of LLC financing is typically more costly than other options.

Recommended: Large Loans for Business

How to Qualify for an LLC Business Loan

Below are some tips for choosing the best loan while also expediting the application process as much as possible.

Determine What You Need

Before you start applying for an LLC business loan, you’ll want to think about what you will do with the loan and exactly how much you will need to accomplish your goal. You may also want to create a detailed plan for how your company will use the funds and what impact you expect the money to have on your business growth.

Recommended: How Much of a Business Loan Can You Get?

Review Loan Requirements

To review loan requirements for a small business loan, start by checking the lender’s criteria, including credit score, business history, and revenue thresholds. Assess the loan amount, interest rates, repayment terms, and required documentation. Ensure the terms align with your business needs and capacity.

Consider Your Qualifications

Key factors lenders look at to determine your eligibility for a loan include:

•  Revenues: Lenders will want to know if your business has sufficient cash flow to repay the loan or financing.

•  Credit: This shows lenders how your company has managed debt in the past. If your business doesn’t have much credit history, the lender will likely want to check your personal credit.

•  Time in business: Many lenders have a minimum time in business requirement. Some require a minimum of two years in business, while others will provide financing to younger businesses and even startups.

•  Collateral: This is a tangible asset pledged to secure the loan. Not all business loans require collateral.

Recommended: Long-Term Small Business Loans

Compare Lenders

There are a variety of business loans available, and it can be wise to compare multiple options to find one with rates and terms that work best for you.

In addition to looking at the interest rate, you may also want to keep an eye out for any other costs, like origination fees (this is a percentage of the loan funds a lender takes as payment for processing the loan) and prepayment fees (a fee charged for paying off the loan early), which also impact the cost of the loan.

Gather Documentation in Advance

It can take time to collect all of the legal and financial documents you need to apply for an LLC business loan. Since most lenders request most of the same information, you can start pulling those documents as you’re rate shopping.

Once you start to apply for a loan, make sure your business loan application includes everything the lender asked for and in the appropriate format. This can help reduce any unnecessary back and forth, allowing you to get a decision as quickly as possible.

Requirements do vary by lender, but we’ve listed some common ones below.

Financial Documentation

•  Business credit report

•  Income tax return

•  Personal financial statements from all owners with at least 20% interest in the LLC

•  Up to one year of business bank statements

•  Projected cash flow, income statements, and balance sheets

•  Collateral documents that outline the value of any assets you intend to secure the loan with

Online lenders may allow you to digitally connect your banking and accounting software to import some of this information directly.

Business Documents

As an LLC, you’ll need to submit your LLC’s Employer Identification Number (EIN) and possibly also your IRS Form SS-4 notice (this is the notice you receive after filing an SS-4 application for your EIN).

You may also need to submit your articles of organization, which designates your registered agent and management structure, as well as your operating agreement to confirm the ownership structure, revenue sharing percentages, and other details.

In addition, a lender might request a business plan to demonstrate the market, competitive landscape, and growth projections after using the loan funds.

Other Important Documents

A lender may also want to see any relevant legal documents that impact the LLC’s finances. This could include existing loan agreements, leases, and contracts with other businesses.

Offer Collateral

And finally, you may want to consider offering collateral to secure your loan. Examples of collateral include equipment, buildings, invoices, home equity, inventory, real estate, vehicles, and securities, such as corporate bonds or certificates of deposit.

Putting up collateral reduces the risk to the lender, allowing them to possibly offer you a lower interest rate or better terms. Keep in mind, though, that if you default on your loan, the lender is able to seize your collateral.

Recommended: Business Loans for Bad Credit

The Takeaway

Getting a business loan as an LLC can help you reach your financial goals with an extra infusion of working capital. The best loan choice will depend on your LLC’s needs, as well as factors like your credit score, if you have collateral, how long you’ve been in business, and your company’s annual revenue.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

Can you get a business loan as an LLC?

Yes. Lenders will review your application just as they would any other type of corporate applicant. You may need to submit documentation like your articles of organization to show the ownership structure. Otherwise, the application process should be similar to any other company’s experience.

Is it hard to get business loans as an LLC?

Each lender has its own criteria for approving business loans, including those for an LLC. Requirements may include a minimum amount of years in business, credit score, and annual revenue.

Can LLCs borrow money from banks?

Banks that offer any type of business loan will allow LLCs to apply. Depending on the loan and your company’s financial history and credit profile, you may be required to provide a personal guarantee. If you do, this eliminates the limited liability protection that typically comes with owning an LLC.

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

SOSMB-Q324-055

As a business owner, it is important to know the difference between working capital and changes in working capital. Working capital tells you the level of assets your business has available to meet its short-term obligations at a given moment in time. Change in working capital, on the other hand, measures what is happening over a given period of time with regard to the liquidity of your company.

Changes in working capital are often used by investors and lenders to assess the health and value of a business. Read on to learn what causes a change in working capital, how to to calculate changes in working capital, and what these changes can tell you about your business.

What Is Net Working Capital?

Net working capital is simply another name for working capital. It is a basic accounting formula companies use to determine their short-term financial health. The basic formula is:

Current Assets – Current Liabilities = Net Working Capital (or Working Capital)

What Is Change in Net Working Capital?

Change in net working capital refers to how a company’s net working capital fluctuates year-over-year. If your net working capital one year was $50,000 and the next year it was $75,000, you would have a positive net working capital change of $25,000.

What Is Working Capital?

Working capital is a company’s current assets minus its current liabilities. Both current assets and current liabilities are found on a company’s balance sheet.

Current assets include assets a company will use in fewer than 12 months in its business operations, such as cash, accounts receivable, and inventories of raw materials and finished goods. Current liabilities include accounts payable, trade credit, short-terms loans, and business lines of credit. Essentially, working capital is the amount of money a company has available to pay its short-term expenses.

Positive Working Capital

A business has positive working capital when it currently has more current assets than current liabilities. This is a sign of financial health, since it means the company will be able to fully cover its short-term obligations as they come due over the next year.

It’s possible to have too much of a good thing, however. Excessive working capital for a prolonged period of time can mean a company is not effectively managing its assets.

Recommended: Net Operating Working Capital (NOWC), Explained

Negative Working Capital

A business has negative working capital when it currently has more liabilities than assets. This can be a temporary situation, such as when a company makes a large payment to a vendor. However, if working capital stays negative for an extended period, it can indicate that the company is struggling to make ends meet and may need to borrow money or take out a working capital loan.

Working Capital Ratio

Another way to measure working capital is to look at the working capital ratio, which is current assets divided by current liabilities. Generally, a working capital ratio of less than 1.0 is an indicator of liquidity problems, while a ratio higher than 2.0 indicates good liquidity.

What Causes Changes in Working Capital?

There are a number of factors that can cause a change in working capital. These include:

Credit Policy

Credit policy adjustments often lead to changes in how quickly cash comes in. A tighter, stricter policy reduces accounts receivable and, in turn, frees up cash. That comes at a potential cost of lower net sales since buyers may shy away from a firm that has highly strict credit policies. Looser credit policies can have the opposite effect. As with many of these factors, there is a tradeoff to weigh.

Accounts Payable Payment Period

Negotiating a longer accounts payable period with your suppliers frees up cash because you have more time to pay your bills.The downside is that a supplier might increase prices in response to allowing a longer payment period. Shortening your accounts payable period can have the opposite effect, so business owners will want to carefully manage this policy.

Collection Policy

A company’s collection policy is a written document that includes the protocol for tackling owed debts. If you’re seeking to increase liquidity, a stricter collection policy could help. Cash comes in sooner (and total accounts receivable shrinks) when there is a short window within which customers can hold off on paying. A less aggressive collection policy has the opposite impact.

Growth Rate

Stronger growth calls for greater investment in accounts receivable and inventory, which uses up cash. This, in turn, can lead to major changes in working capital from one month to the next. A slower growth rate can reduce changes in net working capital.

Inventory Planning

Inventory decisions are a crucial factor that can lead to a change in working capital. If a company chooses to spend more on inventory to increase its fulfillment rate, it will use up more cash. Reducing inventory could free up cash to be used on other business expenses.

Purchasing Practices

A change in purchasing practices can also lead to changes in working capital. If the purchasing department opts to buy larger quantities at one time, it can lower unit prices. However, it means a higher outlay of cash. Buying in smaller amounts can have the opposite effect.

Hedging

Using hedging strategies to offset swings in cash flow can mitigate unexpected changes in working capital. However, there are some costs involved in these hedging transactions, which could affect cash flow.

Recommended: Variable Costing Income Statements

Formula for Calculating Change in Working Capital

The change in working capital formula is straightforward once you know your balance sheet. Simply take current assets and subtract current liabilities. That difference is your working capital (WC).

Next, compare the firm’s working capital in the current period and subtract the working capital amount from the previous period. That difference is the change in working capital.

Change in WC = Current year WC – Last year WC

As an example, let’s say in 2023 your working capital was $75,000. In 2022, your working capital was $50,000. Using the formula above, we have:

Change in WC = $75,000 – $50,000 = $25,000

You can then use this figure to better understand your company’s health. If your firm experiences a positive change in net working capital, it may have more cash to invest in growth opportunities or repay debt. If it experiences a negative change, on the other hand, it can indicate that your company is struggling to meet its short-term obligations.

Why Calculating Changes in Working Capital Is Important

As a small business owner, monitoring and understanding changes in working capital over time, whether it’s quarter-over-quarter or year-over-year, can help you better understand your company’s cash flow.

Working capital is also important if you are trying to woo an investor or get approved for a small business loan. Lenders and investors will often look at both working capital and changes in working capital to assess a company’s financial health. Wide swings from positive to negative working capital can offer clues about a company’s business practices. A business owner can often access more attractive small business loan rates and terms when the firm has a consistent working capital policy.

Recommended: 15 Types of Business Loans to Consider

What Impacts Can Various Changes in Working Capital Have?

Change in working capital is the change in the net working capital of the company from one accounting period to the next. This will happen when either current assets or current liabilities increase or decrease in value.

Change in net working capital is an important indicator of a company’s financial performance and liquidity over time. By calculating the change in working capital, you can better understand your company’s capital cycle and strategize ways to reduce it, either by collecting receivables sooner or, possibly, by delaying accounts payable.

Understanding changes in cash flow is also important if you are applying for a small business loan. Lenders will often look closely at a potential borrower’s working capital and change in working capital from quarter-to-quarter or year-to-year.

Positive Impacts

If the change in working capital is positive, then you have more assets than liabilities. This means the company’s liquidity is increasing.

Negative Impacts

If the change in working capital is negative, it means that the change in the current operating liabilities has increased more than the current operating assets. Cash has been used, and this reduces liquidity.

The Takeaway

Working capital is a basic accounting formula (current assets minus current liabilities) business owners use to determine their short-term financial health. Changes in working capital can occur when either current assets or current liabilities increase or decrease in value.

As a business owner, it’s important to calculate working capital and changes in working capital from one accounting period to another to clearly assess your company’s operational efficiency. This is especially important if you are in the market for financing. Lenders will often look at changes in working capital when assessing a company’s management style and operational efficiency.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

How is change in working capital calculated?

To calculate change in working capital, you first subtract the company’s current liabilities from the company’s current assets to get current working capital. You then take last year’s working capital number and subtract it from this year’s working capital to get change in working capital.

What are some things that can affect working capital?

Items affecting working capital include any changes in current assets and current liabilities. Current assets include cash (and cash equivalents), marketable securities, inventory, accounts receivable, and prepaid expenses. Current liabilities include accounts payable, short-term debt (and the current portion of long-term debt), dividends payable, current deferred revenue liability, and income tax owed within the next year.

What changes in working capital impact cash flow?

Any change in working capital can affect cash flow, which is the net amount of cash and cash equivalents being transferred in and out of a company. If the change in working capital is negative, it reduces cash flow. If the change in working capital is positive, it increases cash flow.

Photo credit: iStock/Hispanolistic

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q324-053

If you’re starting a new business, it’s important to assess its financial ratios and overall performance regularly so you can make appropriate adjustments for its stability and growth. One key assessment involves conducting a break-even analysis.

A break-even analysis determines how much revenue must come in to cover the business’s expenses. It shows how many products must be sold to bring the business to the point at which there isn’t a profit or a loss. This is known as the break-even point.

Read on to learn more about what a break-even point is, how to calculate the break-even point, and how to leverage the results of the break-even point.

What Is a Break-Even Analysis?

A break-even analysis is a financial tool used to determine the point at which a business’s total revenue equals its total costs, resulting in no profit or loss. This point is called the break-even point.

The analysis helps businesses understand how much they need to sell to cover both fixed and variable expenses. By knowing the break-even point, companies can make informed decisions about pricing, cost management, and sales strategies. It’s particularly useful for startups and small businesses to assess financial viability and set realistic sales targets to ensure profitability over time.

Recommended: 10 Steps for Starting a Small Business

Why Conduct a Break-Even Analysis?

The results of a break-even calculation can help you set or adjust pricing, create or modify your budget, and determine or tweak production goals. They can spur on cost-controlling measures and you can show them to your employees to demonstrate the benefits of reaching sales targets. They might also reveal that you could benefit from taking out a small business loan or otherwise accessing more funding.

Here’s a look at one example of how break-even analysis can be an important part of the small business budgeting and price setting processes. Some business owners don’t account for all of the costs that are involved in making a product when they set their prices. Direct costs — such as materials used in a product, manufacturing supplies, and direct labor costs — may be relatively obvious. But indirect labor costs, overhead costs, marketing expenses, and others that are less obvious might not be properly accounted for.

The result could be an under-priced product and a company that struggles to keep its books in the black. Break-even analysis can help you identify that situation so you can rectify it.

So how do you calculate break-even points accurately and use them appropriately? To help you find the answers, here are some useful definitions and some strategies.

Recommended: Small Business Balance Sheets with Examples

How to Calculate Break-Even Points

To understand this calculation, it can help to know the meanings of all of the factors used in it.

•   Fixed costs: These are the company costs that stay the same over a defined period of time. They are costs that have to be paid even when your company isn’t producing anything, like rent payments for building space, salaries, insurance payments, utilities, fixed loan payments, and so forth.

•   Variable costs: Compared to fixed costs, variable costs can change based on business activity. One example might be sales commissions. If a team sells more products, then its commission amounts would increase. If it sells fewer, then this amount would decrease. You may need to estimate what these will be to arrive at a number to use in this equation.

•   Product sales price per unit: This is the cost that a business would charge a customer to buy one of its products.

•   Contribution margin: This is the unit’s sales price minus its variable costs.

Break-Even Point Formula

The formula to calculate break-even point is:

Fixed costs ÷ Contribution margin = Break-even point (expressed in number of products)

Let’s say that a company sells a technical guide and the fixed costs associated with it total $75,000, the variable costs involved in producing one guide equal $3, and the guide sells for $20. This is how this example of break-even analysis plays out:

$75,000 ÷ ($20-$3) = $75,000 ÷ $17 = 4,411.8

This company would therefore need to sell 4,412 copies of the technical guide to reach their break-even point.

Recommended: Annual Revenue Meaning and Calculation

Leveraging Break-Even Calculation Results

If the results of your break-even point are deemed less than desirable, then a review of the business cash management plan, including pricing and more, may make sense.

Solutions can include:

•   Raising prices

•   Finding ways to cut costs

•   A combination of cost cutting and price adjusting

Here’s more information on these actions.

Pricing Strategies

When considering a price change, you’ll probably also want to think about what competitors are charging to make sure your company doesn’t price itself out of the market. If your prices are higher than other companies are charging, is your product more valuable in ways that can justify the higher prices?

Surge Pricing

In certain industries, surge pricing (also known as dynamic pricing) could apply. In this situation, prices rise and fall based on market and customer demand. Concerts and other events might charge higher ticket prices if a certain performer is in high demand, for example. Assuming that company costs remain relatively stable, it will take fewer units to reach the break-even point when demand is high and prices are higher. It will take more units when demand and prices go down.

Discount Price Strategy

A similar strategy called discount price strategy focuses on charging more for popular products. For example, the technical guide company may come out with another publication on a topic that’s highly relevant at present. At that point, the company may be able to sell this new publication at a higher price. The idea behind this strategy’s name is that the product is eventually put into clearance or otherwise discounted after a period of time. This strategy may work especially well with seasonal products or products that go in and out of style, such as clothing.

Penetration Strategy

If a company is just entering the market with a product that already has competition, it might use a penetration strategy in which it prices its offering very low so that the company can “penetrate” the market before raising prices. A break-even analysis would quickly show how larger numbers of products would have to be sold before costs could be covered. That’s why this is typically a short-term strategy to draw attention to a product and start earning revenue from it.

Penetration strategy is related to loss leader pricing, where a few products are priced exceptionally low to grab attention, but other products are still sold at full price.

Cost-Cutting Strategies

One way to cut costs is by looking at your current materials. Can they be purchased for a better price? What kind of discounts can the company get if the materials are bought in greater quantities? What impact could changes based on these factors have on cash flow management, overall?

Another way to reduce fixed costs is to cut back on rent, either by negotiating for better rates, moving to a smaller and/or less expensive space, or shifting to a partly or all-remote working model. This last option could help the business save money on rent, as well as on taxes, insurance, utilities, and so forth.

If your cost for office space can be lowered, check to see what impact this has on the break-even points of your product(s).

Returning to our earlier example of break-even analysis, let’s say that a new rental agreement will reduce the fixed costs of $75,000 by $15,000. Here’s what the break-even analysis would now look like:

$60,000 ÷ ($20-$3) = $60,000 ÷ $17 = 3,529.4. This savings in rent lowered the number of technical guides that would need to be sold from 4,412 to 3,530.

Other cost cutting measures that can lower the fixed costs include:

•   Cutting back on vehicle expenses

•   Strategically using freelancers in the business

•   Price-comparing supplies

Plus, as the proverb has it, time is money. Finding ways to work more efficiently can be real money savers, too. Strategies include improving organization, using productivity apps, and outsourcing strategically.

Recommended: Cash Flow Loans for Your Small Business

The Takeaway

When you own a small business, understanding your break-even point is crucial to your bottom line. You can then use your break-even point to figure out what changes you might want to make in producing your products, whether that’s by adjusting your fixed expenses or variable ones, or adjusting both.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What is the purpose of a break-even analysis?

The purpose of a break-even analysis is to determine the point at which a business’s revenue equals its total costs, meaning no profit or loss is made. It helps businesses understand the minimum sales needed to cover expenses.

What are the limitations of a break-even analysis?

The limitations of a break-even analysis include it doesn’t account for changes in variable costs, economies of scale, or market demand. It assumes all products will be sold at the same price and may not account for sales, discounts, or unsold inventory. Additionally, it focuses solely on profitability, overlooking cash flow and long-term financial health.

What is a good break-even point?

A good break-even point is one that allows a business to cover its costs quickly and consistently at a reasonable sales level. Lower break-even points indicate lower risk and faster profitability, as fewer sales are required to start generating profits.

Photo credit: iStock/Dima Berlin

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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