A loan is an amount borrowed with the promise to pay off on the monthly basis along with a certain amount of interest. A loan that is specifically applied for business purposes is a business loan. When business owners find themselves unable to pay off expenses using their available resources, they require financial assistance and approach lenders for the same.
A loan creates a debt for the borrower. Any business has tons of loan options to choose from. Normally, funds are raised from members of family and close friends circle by most people but many chose to apply for bank loans, business cash advances, equipment financing, invoice financing, working capital loan, loan against property, credit cards, etc.
Traditionally, banks are the most widely preferred source of business finance. However, securing a loan from a bank requires the execution of many procedural formalities.
A business loan can be obtained for different kinds of reasons such as paying basic operating expenses, purchasing land, paying salaries, updating machinery, meeting working capital requirements, purchasing new machinery, purchasing new assets, etc.
A borrower is obliged to understand terms and conditions before applying for business loans, which, among many others, include the tenure of repayment, the interest charged, and the collateral offered by the borrower on the business loan procured. It is expected from a borrower to know how business loans work. In case of any doubt, clear communication between a lender and borrower is necessary, in this regard to avoid future complications.
A lender always needs collateral just in case a business is not able to pay the timely repayment. A lender makes sure that the interest is charged on loans as the price paid for borrowing the money. Interest is either fixed or variable. A fixed interest remains fixed throughout the tenure of repayment. A variable interest rate fluctuates and is dependent upon many factors.
There are many types of business loans. Term loan, for example, is a very common kind and can be secured or unsecured. It’s taken for a specific purpose, say, capital expenditure. In this kind, the lender approves the lump sum amount. The tenure of secured loans is different from unsecured loans.
Whereas, a working capital loan is a small business loan taken to cover shortages of day-to-day expenses. The shortage of off-season is covered with the help of a working capital loan. At times, there is an excess demand from customers during peak seasons, which can be met using working capital loans and is mostly applied by manufacturers, retailers, wholesalers, import-export businesses, etc.
A business loan can be obtained by mortgaging the litigation-free residential property or commercial property to procure funds. Lender ensures that such property is free from any encumbrance. This is the kind of loan typically applied for if the loan amount exceeding Rs.50 Lacs. The tenure for such loans is between 15-20 years.
An overdraft facility is sanctioned after taking into consideration the credit history of the borrower, business cash flow, repayment history, and overall relationship history with the financial institution. Here buyer can pay interest only on the amount utilized and withdraw the amount only to the extent required. The funds are used in this way as long as the principal amount coupled with an interest is repaid timely.
The government of India has come up with various initiatives to encourage women in starting small to medium-sized businesses. To uplift women, a discount on the standard interest rates is offered on a flexible loan amount. Procuring loans is faster due to the faster loan process.
Business credit cards are very useful for procuring funds on an immediate basis. A business owner requires fast cash and wants to earn rewards on the payments done for the debt, then a business credit card is an appropriate option to use.
Facts a Borrower Must Know before applying for a Business Loan
- Know your purpose
Every business is goal-oriented. Goals can be short-term and long-term. They should align with the vision of the company. The management can take strategic or tactical decisions based on the situation, which will make sure that the business is going in the right direction.
There are various purposes for which a business loan may be availed which inter alia include, starting a new business, expansion of existing one, hiring more staff, buying more inventory and raw materials, incurring the cost of advertising, to increase the efficiency through updating, etc.
It’s very crucial to ‘Know your why’. The business loan application must be made only if it is going to help the business grow. It is the right of the lender to know the reason for the business loan application.
- Determine the Business Loan help
The second step is to determine the total amount of business loans required. Knowing how much money the business is falling short of, helps to apply for a business loan accordingly. Borrowing in excess puts a burden on the borrower. Borrowing less than needed will compel the borrower to arrange funds from other sources.
The skill here is to calculate the exact amount of financial assistance needed. A borrower may overestimate or underestimate. The wise thing to do is to make a business loan application for a little higher amount than required to meet unseen, unpredicted, or contingent expenses that may incur.
It’s prudent not to take too much risk. The simplest way to do it is to arrange for less business loan amount, so the burden of paying huge interest can be reduced.
- Shortlist Your Options for Applying for a Loan
Presently, there are so many options available from where business loans can be availed. While some prefer to seek assistance from their family or friends, the most common way is to approach Banks.
- The Collateral Security
Collateral simply means an asset that the borrower offers as security, just in case he fails to repay the loan, and includes any real estate, cash deposits, inventory, etc. The collateral depends upon the purpose for which the loan has been obtained. When it comes to car loans, the car for which the loan has been obtained can be treated as collateral. In the case of a home loan, the home for which the loan has been obtained can be treated as collateral.
Collateral protects the lender in case of default and gives him the authority for the seizure of the secured collateral to make up for the losses incurred.
Having collateral immediately puts the borrower in the good books of the lender, as it indicates the borrower’s ability to repay in the worst scenario possible. A business loan application that has sufficient collateral is preferred by Banks and NBFCs over those who don’t.
- Financial track record
Maintaining books of accounts is a necessity. These include Balance sheets, Profits, and Loss Account, Cash flow statements, Audit reports, and any other prescribed. The lender wants to ensure the timely repayment of the loan and may ask for current business performance, in case the collateral is not provided.
- Equated Monthly Instalments (EMIs)
Equated Monthly Installment or EMI, as they are commonly known, is a fixed predetermined amount that includes both principal and interest that the borrower is liable to pay to the lender every month. This is a payment to be made over the specified number of years till the debt is fully settled. Here the borrower is making sure that the loan is repaid over several years.
A business loan is an obligation on the borrower. It indeed is a commitment. It is very important to know the cost of the loan, before making an application.
The EMI can be calculated based on the tenure of the business loan, the rate of interest, and the loan amount. This helps the borrower in the well-informed decision-making process and also keeps him prepared for the responsibility of repayment.
Important Tips to Give Thought to while applying for a Business Loan
- Keep the Documents Ready:
Keep the financial statements and tax records up to date. Any discrepancies or errors must be detected and corrected in time. Make sure documents and records are maintained, organized and, transparent.
With the help of a qualified Chartered Accountant, financial statements can be compiled promptly without leaving everything to the last minute. This professional help saves the borrower from stress at the last moment, while applying for business loans. This increases the efficiency of the loan application process.
- Knowledge of Your Business
You must know your ‘Why’. The reason for the application for a business loan must be crystal clear. If you are not convinced, you will not able to convince the lender about the same. You should have in-depth knowledge about every aspect of the business. You must know about the past, present, and most importantly, how things are like to take shape in the future.
- The Clear and Honest Communication
After making sure that all records are up-to-date, accurate, in order, and knowing about the purpose of the business loan application, the ongoing communication is treated on a priority basis. Being honest and responding without delay proves very beneficial to the borrower and improves the chances of loan approval. Please take note that the lender is trained to look for inconsistency and critical thinking, so it is very important to be patient while dealing with the officials from the other end. Co-operation, honest and open communication increases the credibility of the borrower thereby helping the process. If any question, queries, or remarks are raised by the lender, the onus to provide a satisfactory answer lies with the borrower. No lender can sanction the loan without proper inquiry. This can be a little testing process but certainly can be overcome.
- Avoid Overburden Early On:
The mistakes most businesses tend to make are to overburden themselves with lots of loans early on, give away all their security as collateral and become incompetent to repay in a short time. This over-commitment may cause a problem in the future when additional financial assistance is needed. The wise thing to do is to align these credit commitments with the long-term objective of the business. Rather than approaching lenders and procuring loans recklessly, think about the long-term impact this move may make on the overall development and growth of the business.
Factors affecting the amount of Business Loan
- Business plan:
The first factor is the properly worked out business plan as it gives a fair idea about the ability of the borrower to repay in near future. The business plan includes the company’s future and ongoing projects, financial overview, marketing analysis and strategies, the planned calculation for making timely repayment of the business loan taken and, gives a clear insight to the lender.
A clear business plan is a great way of convincing lenders that brings transparency and assures timely and regular business loan repayments in the future.
When it comes to small business financing, the lender never approves them without a thorough understanding of the business plan of the borrower.
A business plan gives an outline of where the money is going to be spent and the revenue business is likely to generate in the future.
- Credit Score:
Credit history and the credit report is a very crucial factor in deciding the credibility of the borrower. Credit score information is obtained from the credit report. It’s easy to procure business loans if the credit score is 750 and above. It’s important to have a good track record of regular repayments as it is the easiest way to establish a positive credit score.
- Cash Flow:
The history and records of cash flow maintained indicate how finances are managed in the business. Lenders take into the consideration cash flow of the company to determine the amount required for funding the business. The business loan amount is approved by the lender after taking into consideration the ability of the company to manage the expenditure efficiently.
- Revenue Generating Capacity:
It is very difficult for any business to survive if it is incapable to generate revenue. Hence, lenders will never avoid the revenue projection of a business. So, when such evaluation is presented before the lender, make sure it is realistic and also the chance of the target being achieved is very likely. If the chances of revenue generation are very high, it assures the lender about the repayment of the business loan.
How Can We Help You Get a Business Loan:
Applying for a business loan is a tricky business, indeed especially during these volatile, dynamic and, unpredictable times today. In these times of competition and high demand, not every business loan application is likely to be approved by the lender. Lenders are impressed with the professional behavior or else the loan application may get rejected. With our team of expert professionals, we are here to help you understand the procedure and guide you to procure the loan every step of the way. With us, the process is hassle-free and easy to follow. Our credit score improvement plan has helped many of our clients to transform their businesses. If you are looking for credit score improvement, feel free to contact us!