Skill and effort alone cannot run a business. Any business requires ample amount of finance to grow and expand. Finance is the lifeline of a business. There’s only some money that a business owner can contribute or raise from the public. Business loans are the best alternative to seek financial assistance.
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A business loan is a loan availed for business purposes. These serve for expansion of business, working capital requirements and so on.
To avail a business loan, a business applicant must:
1. Research Business Loan schemes: A number of business loan schemes are available in the market. It is best to research the ones which suit your business.
2. Draft a business plan: Banks need to know why they are funding you. They’d like to have a look at the business plan to get an idea on your business. This will tell them if lending is feasible. They look for a return on investment.
3. Interview with the banker: The banker will want to interview a business representative. Prepare well, as if you are presenting the business plan to investors. This will maximize the chances of getting a business loan. In the interview, a banker might ask the following questions:
1. Do you have collateral?
Collateral is the security that needs to be pledged with the bank to avail a loan. Collateral is a must to avail a secured business loan. This reduces the risk of default and will also improve the chances of getting a loan.
2. Explain the present and projected financial performance
Banks are very interested in the financial performance of the business. They will want to know the past, present and projected financial performance of the business. Banks usually fund businesses that grow steadily.
If you don’t clear the banker’s interview, they will retain a copy of the business plan and request for more documents. These can be financial statements, tax returns and so on. If you clear the interview, bankers will initiate the loan processing.
The most important reason to avail a Business Loan is to grow a business. To earn money, you need to spend it first. A business cannot run without investing in the equipment, advertising, property, and so on.
Managing all these expenses on your own is difficult. Paying for big business expenses upfront is often impossible, at least in the initial stages. Following are some of the reasons to avail a Business Loan:
1. Expansion of business:
Expansion of business needs investments. Investing in a growing business ensures that profits don’t shrink. Growth happens only when an opportunity is seized. It involves various costs like advertising, acquisition of property, renovation, increasing staff and so on. How will you arrange for cash? The best way is to avail a business loan and not dip into the operational funds of the business.
Growth means expanding business operations. Replenishing inventory becomes very important. You have to first invest in inventory and then recover it from the customers, when items are sold. You’ll have to keep up with demand and provide better options to customers to retain them.
Some businesses need seasonal inventory. This is when arranging finance gets difficult. By availing a loan to acquire inventory, a business can meet customer demands and grow.
3. Cash flow:
Small businesses are in dire need of cash This can happen owing to various reasons like delayed payments from customers, unsold finished goods and so on. Combine these costs with the regular costs of inventory, staffing, utilities, rent and so on.
In such situations, business loan can help in running a business without you experiencing a cash crunch.
Equipments are machinery that a manufacturing business uses to manufacture or produce. Equipment is exposed to technological changes. These are expensive, wear down with usage and become obsolete over time.
Equipments need maintenance, repairs and replacement of certain parts which again requires finance. These unplanned expenses can disturb the budget.
Business loans help in managing equipment costs. These in turn, help in keeping the business up to date with new technology which helps in providing better customer experience.
Depending on the needs, there are various types of business loans that a business can choose from:
1. Term Loan:
Term loans are availed to fund the acquisition of expensive assets like land and building, infrastructure, renovation, equipment, vehicles and so on. A term loan has to be repaid after a fixed time (2 to 10 years in India). Term loan interest rate can be fixed or floating. Repayment can be monthly, quarterly or annually.
The Loan To Value (LTV) ratio in case of Term Loans is 75-85% of the asset value. The remaining amount is to be paid as a down-payment.
2. Loan against property (LAP):
A loan against property (LAP) is a secured loan, where property is pledged as collateral. By pledging a property like commercial or residential building or a plot of land, a business can use the money to finance its advertisement campaigns, research and development expenses, expansion, salaries, working capital, land, building and so on.
LAP has a maximum tenure of 15 years. The applicable interest rates are lower than Personal Loan interest rates. The LTV of LAP is 60-70% of the property value.
3. Loan against securities (LAS):
A business can also apply for a Loan against Securities (LAS). The securities that can be pledged are shares, mutual funds, insurance policies, ETFs, FMPs, FDs and so on. On pledging the securities, the bank gives the business an overdraft facility up to a certain limit.
The business will continue to have the ownership benefits on the pledged securities. However, a lien would be placed against the pledged securities. These cannot be sold or redeemed until the loan is repaid.
4. Cash credit facility:
Cash credit facilities are loans given in the form of overdrafts. To avail a cash credit facility, business has to pledge raw materials, work in process (WIP) items, finished goods or accounts/bills receivables. A Cash credit facility is best suited to meet working capital needs.
5. Letter of Credit (LC):
A Letter of Credit is a guarantee given by a bank on behalf of the importer to pay the exporter a specified amount in agreed currency. The exporter has to submit the required documents within a specified time.
If the importer (buyer) is unable to pay for the purchase, the bank will have to make the payment.
1. Business loans are easy to avail and involve minimal paperwork.
2. Business Loans have flexible repayments.
3. Business loans in India can be availed for an amount ranging between Rs 50,000 and Rs 75 Lakhs.
4. The self-employed applicants are sometimes granted higher loan amounts.
5. Additional services like SMS, Web Chat, Phone Banking and so on are provided with business loans.
6. There are various types of business loans which can be availed based on the nature of the requirement. Few examples are loans for working capital requirements, cash flow, and business expansion and so on.
1. Business loans are to be repaid by the business entity. Hence, the owners are not personally liable.
2. Unsecured business loans are availed for reasons like business expansions, working capital requirements and so on.
3. Some business loans offer doorstep service.
4. Some banks offer customers, business loan eligibility in a minute. Speedy approvals help in procuring funds quickly without wasting much time.
5. Business loans can be availed online.
6. Business loans are available for all timelines: short-term, mid-term and long-term.
7. You can choose from different repayment options. You may repay as per the business cash flows or choose bullet payments.
8. Business loans increase business cash flow.
9. These loans make it possible to purchase, lease, repair plant and machinery without disturbing your reserves. These loans facilitate technology up gradation and R&D.
10. These fund raw materials.
Business loans are offered at interest rates ranging from 15-20% a year. A processing fee of up to 2.5% of the loan amount is charged. This differs across banks.
Factors Deciding Business Loan Interest Rates:
Business loan interest rates differ across lenders. The same lenders may sanction the same loan product to different borrowers at different rates. Why is this?
A number of factors affect interest rates of business loans. They are both external and internal.
1. Inflation rate:
Though inflation hikes prices of products and services, it reduces currency value and purchasing power. A decline in currency value increases interest rates. Inflation rates and business loan interest rates are directly related. An increase in inflation results in an increase in business loan interest rate.
2. Monetary policy:
Interest rates increase with an increase in the repo rates. Repo rate is the rate at which commercial banks borrow from RBI. Changes made by the RBI in the monetary policy are reflected in the interest rates. From time to time, the RBI changes the repo rate to control liquidity and inflation. Sometimes the RBI increases repo rate. This reduces liquidity in the market. This increases interest rate on business loans. Vice versa is also true.
3. Demand and Supply of Credit:
The demand and supply of credit also impact business loan interest rates. An increase in the demand for credit increases business loan interest rates. When supply of credit exceeds demand, lenders charge lower interest rates.
4. Type of Business Loan:
A secured business loan has lower interest rates compared to unsecured business loans. Lenders charge high interest rates on unsecured business loans to cover the risk of default.
5. Personal Credit Score:
Lenders check both borrowers’ personal credit score and the business entity’s credit score while processing a business loan. Banks sanction business loans at low interest to those with high credit score and vice versa.
6. Type of Business:
Banks charge high interest rate to businesses considered risky like startups.
7. Annual Turnover:
High annual turnover means the business is in a good financial position. The borrower can easily negotiate with banks for lower interest rates.
You can calculate the Business Loan EMIs using a Business Loan EMI calculator. You have to provide details like the loan amount, interest rate that a bank is charging and the number of years you expect to take the loan for.
After furnishing details, the calculator will give you an estimate on the Business Loan EMIs.
1. Business Loan Interest Rates: On an average, banks charge interest of 15-18% a year on the business loan.
2. Processing Fees: Banks charge 2-3% of the loan amount as processing fees.
3. Prepayment and foreclosure: Banks charge prepayment fees on overdraft and working capital loans. Most banks allow prepayment without charges up to a certain percentage of the outstanding amount. Any prepayment over and above the limit will be charged at 2- 5%.
RBI has directed lenders not to charge prepayment fees on term loans based on floating interest rates.
1. Monthly EMI:
Your past and present financial status impacts home loan EMIs. This is because financial stability decides capacity to pay monthly EMIs. Good financial records decide the interest rate, loan amount and tenure of the loan. Therefore, pay all the EMIs on time. Any default affects CIBIL score.
2. Processing Fee: It is a fee the banks charge, to process the loan amount. This fee is unavoidable and non-refundable.
3. Prepayment: Prepay loans if you have excess funds at disposal.
Compare factors like eligibility, type of interest, interest rate, processing fee, EMI, prepayment fee and so on of different banks and NBFCs before deciding on the lender.
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