Reading about loans can feel like learning a new language, so we designed this guide chock-full of definitions for loan terms that lenders use when talking about their products. Included beneath some of the definitions are links to helpful resources to aid you in your search for the right small-business loan.
Business loan terminology definitions
Accounts receivable financing. This type of financing, also known as factoring, is when your business agrees to sell your invoices and receivables to a third party. You’ll get a percentage of your total invoices at first, then when the third party actually collects the payments for those invoices and receivables, they’ll take an agreed-upon cut and pay you the rest.
Annual percentage rate (APR). Simply put, it’s the price of borrowing money that includes other costs like broker fees and closing costs. The interest rate of the loan is a variable in calculating APR, meaning that APR is more than just the interest rate.
When deciding on a loan product, you should know both the interest rate and the APR to make a fully informed decision.
Assets. Anything owned or controlled by a business owner is considered an asset. Certain assets can be used as collateral for a loan. Acceptable loan collateral varies depending on the lender’s policy, so be sure to ask your lender about which of your assets qualify.
Average monthly payment. This is how much you pay on your loan every month. Loan payments can be required once per month, once per week, or once every other month. No matter your payment structure, it can be useful to calculate the average monthly payment of your loan.
Business credit profile. Also known as a business credit score, this is a collection of reports detailing the credit history of your business. This information is often used by lenders to determine creditworthiness.
There are three companies that collect business credit information: Dun & Bradstreet, Experian, and Equifax. Each has a unique way of determining your creditworthiness, so you should be aware of how each one represents your business credit.
Business line of credit. This is a kind of loan that works more like a credit card. If you have a $10,000 line of credit, for example, you won’t pay a cent of interest until you actually use the money. And when you do use the money, you’ll pay interest on only the amount withdrawn. Once you’ve paid off your balance, the full $10,000 will be available to you again.
Business term loan. Also known as a long-term loan, these loans can be repaid in anywhere from 3 to 10 years. This is the classic loan option for small businesses looking for financing. Because these loans can be paid back over long periods of time, monthly payments are smaller, allowing businesses to invest in stable, long-term growth strategies.
We recently updated our picks for the best small-business loans, and they’re worth a glance if you’re looking for a business term loan.
Cents on the dollar. This measures how many cents the loan costs per dollar borrowed. This usually factors in the interest rate and all additional fees.
Collateral. Collateral is any asset a lender will accept as security for a loan agreement. If the borrower defaults on the loan, the lender has the right to seize and sell the offered collateral.
Gross profit. This is your business’s total profit before deducting any expenses incurred in the creation and dissemination of the product or service. For example, if a cup of coffee costs $1 to make and you sell it for $10, your gross profit is $10. Net profit, on the other hand, would be $9 because, in calculating net profit, you deduct all expenses.
Interest. This is what the bank charges you for the loan. It’s usually represented as a percentage of the total funding amount or principal.
Merchant cash advance (MCA): An MCA is a loan backed by your daily deposits in your merchant credit account. You’ll get a lump sum up front, then the lender will take a cut of your credit deposits until the total loan is paid off with interest.
Net profit. This is your business’s total profit after deducting any expenses incurred in the creation and dissemination of the product or service. For example, if a cup of coffee costs $1 to make and you sell it for $10, your net profit is $9. Gross profit, on the other hand, would be $10 because, in calculating gross profit, you ignore all expenses.
Personal credit score. A personal credit score is a number that represents an individual’s credit history. Small-business owners should avoid leveraging their personal scores for business financing because it will put their personal assets at risk should they default on the loan.
Principal. Principal is the amount of money being borrowed. This number excludes the interest rate and other fees.
Short-term loan. A short-term loan is a loan with a repayment term of 12 months or less. Though 12 months is the most common time frame, some lenders offer short-term loans with repayment terms up to three years and as low as three months.
These loans are best when you need fast cash and can pay off the loan quickly. If you’d like to learn more about short-term loans, check out our review of 2020’s best short-term business loans.
Working capital. Working capital is a key growth indicator that investors may want to calculate. It’s done by subtracting your company’s total liabilities from its total assets. If the resulting sum is positive, you have a positive amount of working capital. This is a sign of potential growth. If the number is negative, your company may be considered in financial decline.
Are we missing any definitions?
If there are other words you’d like us to define, please reach out and let us know. We’re here to help make finding that perfect small-business loan as easy as possible.
Speaking of the perfect small-business loan, if you’re in the market, you may want to check out our Ultimate Guide to Small-Business Loans to learn about your options.