Businesses are organisations or enterprises that are involved in industrial, commercial or professional activities, producing and selling goods and services for a profit. Businesses are significant for an economy as they not only provide products and services for the citizens, and bring in foreign exchange through global trade, but also provide jobs to the working population.
In India itself, small and medium-sized businesses contribute around 7% to the manufacturing GDP and about 25% to the service sector GDP and employ a whopping 40% of the working population, second only to the agricultural sector.
Businesses need funds to use for their regular operational costs, like paying rents, utility bills, wages, etc. Most often, these come from profits the business earns. However, there are circumstances when benefits are low, and the company needs money to stay afloat. Funds are also required when a business has to expand by purchasing properties, equipment, or inventory. This is where business loans come into the picture.
Types Of Business Loans
There are several kinds of loans for businesses, most of which are short and long-term loans, or loans that one can obtain with and without collateral.
One of the most common ways for businesses to secure funds is by using the overdraft facilities. These overdraft facilities are provided by the banks. Overdrafts are financial instruments in which one can draw money. One can draw money from the account even if the balance goes zero or negative. Banks offer this facility as a type of extension of monetary limit, and the money ‘overdraws.’
Banks offer an assigned limit of overdraft facility to account holders depending upon the number and amount of transactions, account holder’s credit score, and his relationship with the bank. It is a short-term credit facility and attracts interest only on the amount one overdraws and not on the limit one assigns.
It is a significantly useful credit facility provided by banks, offering aid to businesses by increasing the cash flow and helping them meet their working capital expenditure. As per RBI regulations, current accounts are eligible for a maximum Rs. 50,000 credit per week.
2. Working Capital Loan
When a business does not have cash on hand, or asset liquidity to cover the day-to-day expenditures such as payroll, rent, or debt payments, working capital loans come to rescue. These are short-term loans, that one uses to back an enterprise’s everyday operations, especially during periods of low business activity.
Businessmen don’t use working capital loans to buy long-term assets or investments, and thus have a tenure of 12 to 18 months. Mostly, businesses who do not have stable or predictable revenue throughout the year or those with seasonal or cyclical income, use these.
Working capital loans may or may not be secure enough, depending upon the credit score of the owner. The interest rate on this credit facility is lesser than overdrafts, around 12-16%, and bank charges interest only on the amount one utilises, and not on the entire amount one sanctions.
Working capital loans are, however, sanctioned against a defined purpose and plan of business only, giving banks the right to revoke the loan if the set parameters and expectations are not met by the business.
3. Term Loans
These are the standard kind of loans that one can take for both personal and business purposes. Here, one applies for credit for a specific purpose to get a lump sum amount. These are generally long-term in nature, and the tenure can range from around 5-20 years. Term loans generally have a lower interest rate, and a higher sanctioned amount, again depending on the profile and credit history of the business owner.
We generally use term loans for long-term goals, such as asset purchase or capital expenditure. These loans are usually backed by collateral, but can also be unsecured in some cases. The business owner usually has to give the reason for taking the loan, as well as show his financial projections and loan repayment capacity.
4. Line Of Credit
A bank Line of Credit is a very popular type of business loan. Businesses have been using this form of credit facility for years to take advantage of strategic investment opportunities or meeting working capital needs.
It is basically a very flexible loan from a bank. It’s like a credit card that allows you to use money up to a limit, whenever and however you want. You can use this money whenever you want and pay either immediately, or over a specified period. It charges lower interest rates and thus provides businesses with a cushion when one requires cash immediately.
5. Invoice Financing
Invoice financing is a powerful tool for businesses to raise capital against the amounts due from its customers. It helps businesses pay the employees and suppliers, and reinvest in business operation and growth. Also, increased cash flow as a whole than they could if they had to wait for their customers to pay their balance in full. Banks charge a percentage of the invoice amount as a fee for lending the money.
Invoice financing solves problems with customers taking a long time to pay. About 80% of the invoice is given as a loan to the borrower, with invoices acting as collateral, and the remaining when the customer pays in full.
6. Pradhan Mantri Mudra Yojna (PMMY):
The Prime Minister of India, Narendra Modi, launched the PMMY scheme, especially for medium and small-scale enterprises. It was for the enterprises in the manufacturing, trading and services sector, including allied agricultural activities. This scheme provides credit facility in the form of working capital loans or term loans. It is for expansion of business capacity, or modernisation.
The commercial banks, cooperative banks, small finance banks, and other financial institutions provide collateral-free credit. It has a tenure ranging from 3-5 years. The bank has categorised the scheme depending upon the amount and varies in margin and processing fee.
Almost all the commercial banks provide all the above-listed types of credit facilities to business owners. Some of these credit facilities require the business owner to have a good credit score. Also, the owner should have a good relationship with the bank to qualify for the facility. This will help you sanction a larger loan amount with a lesser rate of interest as well.