Introduction
Beginning a business or an expansion requires sizeable capital outlay. Few entrepreneurs are luckier to be well-capitalized, while for many, a business loan has been the gateway to success. In India, there are countless business loan schemes that cater to different financial requirements. With various types of business loans offered by banks, non-banking financial companies (NBFCs), and government schemes, entrepreneurs can secure funding to ensure smooth operations, business expansion, or manage unforeseen expenses. Let’s delve deeper into the different types of business loans available in India and explore how they can benefit businesses in different stages of growth.
1. Term Loan
A term loan is one of the most common and traditional forms of business financing. It is usually offered by banks or financial institutions to businesses in need of capital for long-term investments. The loan amount is repaid over a fixed term, which can range from one year to five years or even more, depending on the agreement.
Funds from a term loan can be used for any purpose, including the setting up of new infrastructure, purchase of machinery, expansion of production capabilities, or even covering the costs of research and development. Term loans come with fixed and variable interest rates, thus providing businesses with some flexibility in managing their finances. Term loans are granted for huge sums, but businesses must make monthly payments with principal and interest combined until the loan is completely repaid.
Term loans are appropriate for companies that need a lot of money for expansion or investing in capital assets. The loans are predictable and enable companies to prepare their financial strategies.
2. Working Capital Loan
A working capital loan is specifically meant to finance the day-to-day running of a business. Businesses often experience fluctuations in cash flow due to seasonal demand, delayed payments from customers, or unexpected expenses. A working capital loan helps businesses meet these short-term financial challenges by providing immediate funds.
This type of loan is used for several short-term requirements like purchasing raw materials, paying wages and salaries, managing inventory, or covering utility bills. The repayment period for working capital loans is usually very short, usually between a few months to one year. In most cases, the loan amount is determined according to the business’s cash flow. This means the loan is tied directly to the business’s short-term ability to generate revenue.
Since working capital loans do not require any form of collateral in most cases, they are regarded as an unsecured form of financing, making them accessible to small businesses and startups.
3. Overdraft Facility
An overdraft is a short-term loan to cover a business cash shortfall-an overdraft facility permits to advance more than the balance in the account, within a fixed limit. It serves as a good solution for organizations that have liquidity crises and require immediate funds to settle urgent expenses.
The primary benefit of an overdraft facility is its flexibility. Businesses are allowed to pay only for the overdraft amount used, and upon repayment of the overdraft, they can borrow the funds once again. A revolving credit arrangement is more workable for managing unexpected costs or temporary dips in cash flow by businesses.
Banks commonly provide overdraft facilities and can offer them to both small and large businesses. The interest rates charged on overdraft loans are, however, relatively higher than most other forms of finance, which should be taken into account by the business before availing the facility.
4. Secured Business Loan
Secured business loan: A type of financing wherein the borrower offers some collateral as security for the loan. Such collateral can be assets such as property, machinery, inventory, or even future receivables. The amount for secured loans is usually larger as the lender knows that in case the borrower defaults on the repayment, he/she can recover the amount from the offered collateral.
Secured loans have benefits, including reduced interest rates and extended repayment time. This is because the lenders are taking on less risk. Secured business loans can provide capital to those businesses with worthwhile assets but fail to access other types of financing due to insufficient collateral.
Although secured loans are more favorable, businesses should be cautious of the implications of pledging valuable assets. In case of non-payment, the lender has the right to seize the collateral to recover the outstanding loan amount.
5. Unsecured Business Loan
Unsecured business loans are such loans that require no collateral security for borrowing. These loans are offered on the basis of borrower’s credit worthiness, performance of business and financial history. Unsecured loans are the best option for small businesses, start-ups, or companies which don’t have some valuable assets to pledge.
Since the unsecured loan involves more risk to the lender, the interest rate on the unsecured loan is higher than on a secured loan. On the other hand, the process for approval of an unsecured loan is quicker and businesses are not at the risk of losing any assets in case of default.
An unsecured business loan would be ideal for entrepreneurs who want quick funds in working capital or short-term expenses to run a business or even for other instant needs. The loan is appropriate for businesses that have a robust credit profile with a proven profitability track record.
6. Equipment Financing
Specialized solutions, such as equipment financing, are available for businesses requiring new machinery or tools, and sometimes even vehicles. This is a type of loan that enables businesses to purchase or lease equipment and pay for it over time. The company acquires the equipment itself as collateral, making it easier for businesses to acquire essential assets without draining their cash reserves.
Such loans are offered in the industries of manufacturing, construction, logistics, and healthcare, where specialized equipment is a must for the business. The loan terms are also preferable with lower interest rates and repayment terms corresponding to the useful life of the equipment.
The advantage of such equipment financing to the business is being able to enhance productivity and stay competitive without needing significant major capital investments.
7. Business Line of Credit
A business line of credit is basically a flexible option in financing like a credit card. It’s the access, on a revolving credit basis, that enables businesses to get money from which they can take funds as necessary. Interest only is charged to the amount taken, and at any time that businesses pay this amount back they can borrow the same amount of money again in continuous access of funds.
A line of credit is best suited to businesses with fluctuating expenses or seasonal demand. For instance, a retailer can use a line of credit to purchase inventory before a busy season and pay it off when the sales are made. This type of financing is quite flexible and helps in managing cash flow gaps.
Business lines of credit may be unsecured or secured, depending on the credit worthiness of the borrower and the requirements of the financial institution.
8. Invoice Financing
Invoice financing, otherwise known as accounts receivable financing, allows companies to borrow against their outstanding invoices. If a company sells on credit, the money from a customer may be delayed for weeks or months, so invoice financing provides businesses with liquidity by providing them with a loan based on the value of their unpaid invoices.
Two different types of invoice financing exist. These are called factoring and discounting. In factoring, the lender purchases the invoices at a discount, meaning that the business gets immediate cash. In the case of invoice discounting, the business gets to keep the invoices but obtains a loan, based on their value.
This loan is very helpful for businesses with long credit cycles because it allows them to access cash quickly without waiting for customer payments.
9. Small Business Loans
Loans to small businesses are available specifically for small-scale enterprises, including entrepreneurs and micro-enterprises. These loans are offered by banks, NBFCs, or the government in some schemes. The Government of India has launched several initiatives, such as the Pradhan Mantri Mudra Yojana (PMMY), which provides loans to small industries, particularly in rural and semi-urban areas.
The small business loans tend to have a lower interest rate and more attractive terms to spur the growth of small-scale ventures. They can be used for operational costs, expansion of the operations of the business, or for establishing new businesses. Because of their accessibility, small business loans are in great demand among the entrepreneurs who intend to expand their businesses.
10. Trade Credit
Trade credit provides financing through suppliers to businesses. In trade credit, suppliers sell goods or services to a business by granting a business time to pay after a specified period. Trade credit is offered to businesses, mainly if the suppliers have been dealing with the business for a long time or if they have a good financial record.
Trade credit enables businesses to manage their cash flow effectively. It does not require immediate payments for inventory or services. Most retail and wholesale industries use such financing, while it is absolutely necessary for firms that rely heavily on large amounts of goods in their operations.
Conclusion
In India, various business loans are available to entrepreneurs, which give them ample opportunities to fund their business needs. Whether they are looking to expand, manage day-to-day operations, or invest in new technology, entrepreneurs can find the perfect business loan that suits their needs. Each type of business loan has its own set of benefits and challenges, which entrepreneurs need to assess before making a decision.
Understanding the different type of business loan will help to determine the option that best suit the financial aspect, business vision, and how much the businesses can repay so that they end up with better deals from each financial institution against the interest and terms and then eligibility criteria. Whether you’re a startup or an established enterprise, there is a loan that can meet your requirements and provide the necessary funding for your business success.
