Business, be it big or small, is always in need of funds. Whether the promoters pool in money or raise money from the market depends on the size and business viability. It also depends upon the nature of the business – is it capital-intensive and what is its stage of development, in terms of inception, growth or maturity? Usually businesses need funds the most in the growth stage which stabilizes in a mature business with only depreciated capital and working capital needs.
Commercial or Business Loans are mainly categorized either as:
- Secured Loans
- Unsecured Loans
However, broadly there are two types of loans available in India as Commercial or Business Loans:
- Professional Loans
- Trade Loans
Let us look at both Professional and Trade Loans in details, which can be both Secured or Unsecured and Short Term or Long Term in nature as per the terms and conditions mentioned by the bank or the NBFC (Non banking Financial Corporation) which provides the loan.
Professional loans are extended to self employed professionals such as doctors, chartered accountants and lawyers, based on their individual credit history. It also varies from bank to bank as to how much loan they can extend to that individual and the latter’s relationship with the particular bank. This loan is usually extended on personal rapport basis and in many instances some kind of collateral is taken in the form of mortgage of non-agricultural land, National Savings Certificates, Government Bonds, Bank’s Term Deposits, and Assignment of Life Insurance Policies etc. especially for loans extending over a certain threshold limit of say Rs 15-20 lacs. These loans are usually long term in nature and have payback tenure of about 5-7 years.
The documents that are required for the loan approval include:
- Detailed plan of the utilization of the money and the repayment methodology
- Business expansion plan
- Personal financial statements for the last 12 months including bank account statements, CIBIL score, etc.
- Some form of collateral for a higher loan amount
- Documents of the business, if it is established:
- Certification of incorporation
- Self attested photocopy of PAN Card and address proof of the business
- Ownership document
- Last 2 year’s balance sheet and IT returns
- Personal Credit References
Type of businesses that can apply for Trade Loans are:
- Sole Proprietorships
- Private Limited Companies
Trade Loans mainly comprise 3 types:
Overdraft loans are usually based on some collateral or securities especially in terms of Bank Fixed Deposits. Usually a bank, depending upon the credit history, cash flows, tenure of banking relationship and the repayment history of the business or individual promoter takes an approval for a certain fixed overdraft limit. Based on the limit, the overdraft amount can be utilized and interest is charged by the bank only on the utilized amount. This loan can be utilized in any manner as long as the principal and the interest is being repaid on time.
Overdraft limit is also available on an individual basis for personal utilization based on his credit history.
Working Capital Loan
Working capital loans are usually provided to businesses as regular working capital. This loan is also against collateral and has a lesser rate of interest than overdrafts. In this type of a loan as well, interest is charged by the bank only on the utilized amount and not on the entire sanctioned amount.
In a working capital loan, the bank sets a limit for the business to take a loan and the amount can be utilized in a specific purpose only, i.e. the working of the business and cannot be utilized in any other manner. This type of loan is sanctioned against the defined purpose and the plan of the business. The banks take full control of monitoring the order book of the business with its debtors, receivables, cash flow, inventory, etc. The bank also has the right to revoke the loan if the set parameters and expectations defined are not met as per the banking standards and norms.
Thus, banks are more comfortable in giving working capital loans than other types so that the entire audit and control in under their supervision and they are in full control of the profitability and the working cash flow of the business and thus chances of default are much lower.
In working capital loans, banks check the financial health of the business in a regular and audited manner.
Term loans are the standard type of loan that can be for both personal and business purposes. The entire amount in a term loan is disbursed and is EMI (Equal Monthly Installments) based for a specific pre-defined tenure.
Term loans can be taken in foreign currency as well and is termed as Foreign Currency loans. Such loans are usually extended to exporters who deal in a different currency. This type of loan is cheaper than domestic loans as cost of capital employment is cheaper outside India. In Foreign Currency Loan, the loan amount is calculated in USD and converted and paid to the business in India as INR and is set off against USD payments received by the business.
The other variant is for domestic businesses in Domestic Currency Loan where the rate of Interest is pre-defined for a specific tenure and is EMI based as well.
The documents that are required for the loan approval include:
- Business continuity proof for at least 2 years as:
- Last 2 years’ bank statements with regular cash flows
- Salary payment for 2 years. Utility Bills, etc.
- Last 3 years audited Balance Sheet along with financial statements, Profit and Loss statement and ITR
- Certificate of Incorporation/Registration or Partnership/Trust Deed, etc.
- Self attested photocopy of Company PAN Card and Address Proof along with Board Resolution and authorized list of signatories and MOA and AOA
- KYC of the individual promoters of directors: Self Attested Photocopy of PAN Card and Address Proof and photograph
The interest rates charged to all the above mentioned types of loans vary from 8%–15% and depends on the economic condition of the country and the amount of loan sanctioned. The interest rates in the economy have dropped in the last 6 months over 30bps. Generally, one is expected to repay the amount in a maximum tenure of 5 years with some periodicity of repayment inbuilt and it can always be extended thereafter.
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