Financing Through Loans

If you have never received a loan to finance something, you are certainly in the minority! Loans can be a great thing, but they can also get you into trouble. One of the keys to being financially successful is understanding when loans are a good solution for your situation. Loans are never a good idea if you can’t afford to pay them back in the required time frame. Loans can be great thing that happened to you when its helps to increase your net worth. Particularly in business world loans helps to finance various business plans/projects so that it can increase our equity after repaying the Loans by using cash flows generated from the plans /Projects financed through such loans. Take a look at various aspects business financing:

Why Business Need Finance?

Right from the moment someone thinks of a business idea, there needs to be funds. As the business grows there are inevitably greater calls for more money to finance expansion. The day to day running of the business also needs money.

Finance is the money available to spend on business needs.

Business needs finance to fund the following:

  • Depending on the type of business, it will need to finance the purchase of assets, materials and employing people.
  • As a business grows, it needs higher capacity and new technology to cut unit costs and keep up with competitors. New technology can be relatively expensive to the business and is seen as a long term investment, because the costs will outweigh the money saved or generated for a considerable period of time
  • For build-up of current assets and fixed assets needed for business purpose, capacity expansion, modernization, short term working capital (including shoring up of Net Working Capital, etc).
  • In fast moving markets, where competitors are constantly updating their products, a business needs to spend money on developing and marketing new products e.g. to do marketing research and test new products in “pilot” markets
  • When a business seeks to expand it may look to sell their products into new markets. These can be new geographical areas to sell to (e.g. export markets) or new types of customers.
  • When a business buys another business, it will need to find money to pay for the acquisition (acquisitions involve significant investment).
  • Finance is needed to pay for expenses such as the cost of renting of removal vans, through to relocation packages for employees and the installation of machinery.
  • A business has many calls on its cash on a day to day basis, from paying a supplier for raw materials, paying the wages through to buying a new printer cartridge.

  

Source of Finance:

Long Term-Finance:

Short-term finance

  • Issue of shares
  • Issue of Debentures
  • Retention of Profits.
  • Loans from Financial Institutions
  • Loans from Commercial Banks
  • Public Deposits

 

  • Loans from Commercial Banks
  • Public Deposits
  • Trade Credit
  • Factoring
  • Discounting Bills of Exchange
  • Bank Overdraft and Cash Credit
  • Advances from Customers
  • Accrual Accounts.


Financing from Commercial Banks:

Type

Loan Purpose Interest Rate

Documents Required

Term Loans Project & Capex loans Medium Term Loans 5-7 years or longer in exceptional cases. to buy Commercial assets, set up a new industrial unit or expand/modernize existing unit. Base Rate (BR) upwards.
  • Collateral
  • Business plan
  • All of your business’s financial details
  • Complete details on Accounts Receivable
  • Complete details on Accounts Payable
  • Complete financial statements, preferably audited or reviewed
  • All of your personal financial details
  • Insurance information
  • Copies of past returns
  • Agreement on future ratios
Short Term Corporate Loans For Shoring up Net Working Capital, Ongoing capital expenditure, Repayment of high cost debt, R&D expenditure, implementation of VRS Linked to  Base Rate (BR)
Working Capital Loans Cash Credit Cash Credit facility Linked to  Base Rate (BR)
Overdraft Overdraft Facility  Linked to  Base Rate (BR)
Export Credits Packing Credit, Post shipment , Forfaiting LIBOR linked and Market Determined
Securitized loans Up fronting of assured cash flow emanating from future receivables viz. rentals, Royalties, debtors, Lease rentals etc. Based on risk rating
Channel Financing Bank offers short term working capital facilities to the supply chain stake holders i.e. buyer and the supplier. Linked to Base Rate (BR)
Letter of Credits(LCs), Guarantees, Deferred Payment Guarantees(DPGs) and Letter of Comfort For import of goods including capital goods participation in international bids, performance guarantees etc. Fee Based Product
Foreign Currency Loans Projects & Work. Cap External Commercial Borrowings(ECBs),Buyers ‘Credit and Seller’s Credit, Bilateral loans in all major currencies, ECA backed credits, Pre-bid and post bid facilities for project exports and FCNR(B) Loans LIBOR linked


Note:

Banks can link their Retail lending interest rate to any one of the four external benchmarks:

  • RBI’s repo rate
  • Government of India 3-months Treasury bill yield published by Financial Benchmarks India Pvt. Ltd. (FBIL)
  • Government of India 6-months Treasury bill yield published by FBIL
  • Any other benchmark market interest rate published by FBIL

 Advantages of bank Loans:

  • A bank loan allows one to repay as per convenience as long as the instalments are regular and timely. Unlike an overdraft where all the credit is deducted in go. Or a consumer credit card where the maximum limit cannot be utilized in one go.
  • The loan is not repayable on demand and so available for the term of the loan – generally three to ten years – unless we breach the loan conditions.
  • Loans can be tied to the lifetime of the equipment or other assets we’re borrowing the money to pay for.
  • When it comes to interest rates, bank loans are usually the cheapest option compared to loans from other parties.
  • When we raise funds through equity we have to share profits with shareholders. However, in a bank loan raised finance we do not have to share profits with the bank.
  • Government makes the interest payable on the loan a tax-deductible item when the loan has been taken for business purpose.

Disadvantages of Bank Loans:

  • Since big finance from a bank is based on collateral, most young businesses will find it hard to finance the operations based on bank loan.
  • Over a long duration payback via monthly instalment might witness variation in the rate of interest. This means that the EMI will not be constant, rather it will change as per the influence of the market on the interest applicable.
  • Business could have trouble making monthly repayments if customers don’t pay you promptly, causing cash flow problems.
  • There may be a charge if we want to repay the loan before the end of the loan term, particularly if the interest rate on the loan is fixed.

Utilization of Funds:

Funds utilization is guided by the ultimate aim of any business i.e. profit and wealth maximization.

Effective and efficient fund utilization enables organizations in profit and wealth/ returns maximization, minimization of the cost of capital, improving savings and bettering its value. When funds are optimally utilized, it will help the organization grow and flourish in the long-run.

If funds are under- or over-utilized or mismanaged, it will be detrimental to the sustainability, viability and growth of the organization, which may even have to shut down operations as a result.

Utilization of funds also impacts the liquidity, safety and risk management of the organization.

Organizations need liquidity and cash flow in the short-term in order to meet their operational costs, working capital requirements and emergencies. The level of cash flow and liquidity have an impact on the credit-worthiness of the organization.

Normally, Short-term Funding is directed towards the working capital needs (Opex) while Long-term funding is directed towards capital expenditure (Capex). Directing short-term funding towards long term uses (in most cases) is the major cause of borrowers default!

Use of short-term funding in the long-term financing resulting negative working capital, imbalance in liquidity and also the inability to repay short-term obligations

An appropriate consultant/ advisor shall be able to guide to manage your fund utilization and recommending right source of funding for the business. Considering the current position of financial health and future objectives a strategic financial plan can be laid out and implemented.

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