A loan is a sum of money borrowed for a specified period of time and repaid according to a predetermined repayment schedule. The amount of the loan repayment will be determined by the size and duration of the loan, as well as the rate of interest.
Loans are most commonly used for the following purposes:
- paying for assets such as vehicles and computers, for example
- a sum of money used to start a business
- There are some situations in which the amount of money you require will not change.
The terms and prices of loans will differ between lenders, and they will reflect the risk and cost to the bank associated with providing the loan financing. Pricing and terms may be able to be negotiated for larger sums of money.
Banks will loan money to businesses on the condition that they will receive an adequate return on their investment, that the risks of default will be taken into consideration, and that the loan will cover administrative costs. If you have a long-standing relationship with your bank, they will have gained an in-depth understanding of your operations and finances. This will assist them in advising you on the most appropriate product for your financial requirements.
There are several types of bank loans, including:
- working capital loans - for situations requiring quick action or an emergency.
- Fixed asset loans - for the purchase of assets in which the asset itself serves as collateral
- Customers owe your company money, and factoring loans are loans based on the money they owe you.
- Hire purchase loans are used to finance the long-term acquisition of assets such as vehicles or machinery.
Aspects of term loans that are advantageous
- You will not be required to repay the loan on demand, and it will remain available for the duration of the loan, which is typically three to ten years, unless you violate the loan terms.
- Loans can be tied to the useful life of the equipment or other assets that you are borrowing money to purchase with the money you borrow.
- You may be able to negotiate a repayment holiday at the beginning of the loan's term, which means that you will only be required to make interest payments for a specified period of time while capital repayments are frozen.
- You must pay interest on your loan; however, you are not required to give the lender a percentage of your profits or a stake in your company in exchange.
- Interest rates may be fixed for the duration of the loan, allowing you to predict the amount of money you will have to pay back over the course of the loan's life.
- There may be an arrangement fee that must be paid at the beginning of the loan but not at any other time during its term. If it is an on-demand loan, there may be an annual renewal fee that must be paid.
Loans have a number of disadvantages.
- In the case of larger loans, you will be required to comply with certain terms and conditions, known as covenants, such as the provision of quarterly management information to the lender.
- When it comes to loans, they are not very flexible; you could end up paying interest on funds that you are not using.
- If your customers do not pay you on time, you may have difficulty making your monthly repayments, which could result in cashflow problems.
- The assets of the business or your personal possessions, such as your home, may be used as collateral to secure loans in some cases. Although secured loans may have lower interest rates than unsecured loans, your assets or home may be at risk if you are unable to make your loan repayments.
- In some cases, if you want to repay the loan before the end of the loan term, you may be required to pay an additional fee, particularly if the interest rate on the loan is fixed.
When a loan is deemed unsuitable
To borrow money to cover ongoing expenses is not a good idea because it may be difficult to keep up with the repayments on time. Ongoing expenses, on the other hand, are best funded by cash received from sales, possibly with an overdraft as a backup plan in place.
You have a variety of financing options if you are unable to obtain a loan or other type of financing from your financial institution of choice. For more information, see Business financing options - an overview for a comprehensive list of resources.
If you believe that a bank loan may be a viable option for your company, see Getting Your Company Ready for Bank Financing for more information.
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