This article is written by Abhishek Dubey student of BBA LL.B in 2nd year. The article discusses the different types of credit facilities provided by banks, including some of the essentials of the loan agreement as well as documents required for getting business loans etc.
There are two types of credit facilities long term and short term. Short term credit is required to meet the regular expenses of business such as paying the creditor and purchase of raw materials. While a long term credit is used to meet the capital expenditure such as for the purchase of assets, construction and maintenance of the building.
These are financed by banks, private placement. For raising equity by Initial Public offering or any other convertible securities there are various methods available to the company. Business owners may use such method of raising credit that would help them retain control of businessmen over the business.
Types of Credit Facilities for banks
Short term loans
A company can borrow short term loans for its working capital needs for a period of six months or a year. This type of credit facility may or may not be secured in nature. It depends upon the credit rating of the borrower. A strong borrower such as from the investment-grade category may be able to borrow on an unsecured basis. On the other hand, the non-vested borrower may borrow short term credit by providing collateral securities for loans such as short term receivables and inventories.
A large corporation also borrows short term loans for a specified period of time and for a specified amount. The specified time can be up to 5 years but the interest rate is higher as compared to a non-investment borrower and investment category borrower. A borrowing base facility is a secured form of short term loans provided only to commodities trading firms.
Following are the parts of short term loans by the banks:
Merchant cash advances
In this type of credit facility, a company can withdraw funds more than its deposits. The borrower would then be required to pay the interest on additional amount apart from deposits.
Letter of credit
This type of credit facility is most suitable for the company which mainly deals with cash. A supplier feels secure to give credit to the customer with whom he has a good relationship. The negotiation of good payment terms with the supplier is very important for having a profitable transaction. An example of a good payment term can be 2 per cent discount if payment has been made within 10 days.
But there may be circumstances, the supplier immediately so a customer or a businessman may borrow from banks for the short term credit. Letter of credit gives a facility to the company by which a bank guarantee is given to the supplier for payment on behalf of the company. This letter of credit is issued to the supplier by banks and collateral security is provided by the company.
Payday loans are emergency short term loans which are easy to obtain. Even banks offer this type of loan to street vendors. The disadvantage of payday loans is that the entire amount and interest amount should be paid in one instalment.
Online or instalment loans
It is also a short term facility provided by the bank. In this form, an application is filed online by the borrower for approval. After approval within minutes, the money is transferred to the borrower’s account.
Invoice is a document which shows the amount unpaid by the customer in business. The lender loans the money and charges the interest based on the number of days that invoice remains unpaid. As soon as the invoice gets paid the lender will interrupt the invoice, charge the interest on the loan and will ask the borrower to pay the whole money and interest.
How to apply for short term loans
1. Know the reason and amount of loan
It is well known that short term loans are applied mostly by small businessmen. The owner should know the reason and the amount of loan needed. If it is a startup, then the owner of startups should know the number of funds that are required. Whether the firm is existing or startups they should prepare the financial statement for their business plan.
2. Visit your local score and SDFC office
The local score is a social and volunteer organization involved in advising the owner of a business. This organization consists of a business executive. If you do not have a score in your area then consult with SDFC, If your business location or your location is near to the university. SDFC is a part of small business administrator which advise startups and small businesses. Application has to be made for advice moreover, online counselling can be also taken.
3. Review your credit history and credit score
Generally, if your business is less than 3 years old, your creditor history and creditor score will be reviewed by banks. Before you apply for a loan request, a credit report of your business should be consulted with a consultant. 700 is a good score for which, a chance for getting a loan is higher.
4. Start reviewing your borrowing options
Generally, large commercial banks have a tough procedure for getting a loan approved. So another option available to a businessman is to visit regional commercial banks. Other options are also available apart from commercial banks such as local credit union if you are a member of the credit union.
5. Prepare for a business plan
This is one of the most important steps for applying and getting approval of your loan. Preparation of a business plan is mandated by a financial institution apart from the loan application. The business plan consists of many parts such as a past and present financial statement of the business and collateral security of businessmen.
Long term and intermediate business loans in India
Long term loans
Long term loans carry fixed maturities, the maturity period can be for 10 years or up to 20 years.
Long term loans are always supported by collateral i.e company assets. The long term loans contain various conditions. For example, the condition can be a company cannot take a loan from other banks until and unless it does not repay this loan.
Purpose of long term loans
Long term loans are usually taken by a business when they are purchasing equipment for the manufacturing, construction and maintenance of the building. A short term loan will not be appropriate for this purpose.
Getting a long term loan
Getting a long term loan is difficult for startups. Only a well-established businessman can avail long term loans. A business needs to present its business plans and as well as its historical and financial records for getting the long term loans.
A business needs to show the future plan that it can repay the amount for startups. The advantage of long term loans is that it charges less interest than short term loans.
Obtaining a long term loan
Obtaining a long term loan depends upon many factors including the bank chosen, the financial strength of the company, the economy of the country, the condition of the economy such as boom or recession period etc.
How midterm loans differ from long term loans
The intermediate-term loans differ from long term loans. The maturity period may be from 1 to 3 years but the approval process of short term and long term loan is the same. This type of loan is generally taken by the business for short term assets such as computer systems, operating the business etc. Their life span is not for more than 3 years. Payment to banks is made quarterly or monthly.
Documents required for a different business plan
It is possible for the business to grow by purchasing business equipment and grow its business by obtaining a loan from banks. Each bank has a specific requirement. Here is the list of few documents required by banks apart from the application:
- Identity proof: This includes aadhar card, driving license, pan card etc.
- Address proof: This includes ration card, telephone bill, electricity bill, passport etc.
- Income proof: Bank statement for the last 2 years.
- Financial documents: Last 2 years of income tax return along with balance sheet, income and profit and loss account.
- Proof of business continuation.
- Business ownership proof: Last 3 years of audited financial, along with the sole proprietor, and a copy of the memorandum of understanding and article of association.
List of commonly required documents by most of the lenders for business loans
- Loan application form with one passport size photo.
- Valid proof of the borrower: passport, pan card, identity card, driving license etc.
- Proof of residence: ration card, telephone bill, sales tax certificate.
- Proof of age: Passport, pan card, identity card etc.
- Financial documents: copies of income tax returns for 2 years, balance sheet audited by CA for 2 years.
- Profit and loss balance sheet for the last 2 years.
- Proof of identity for Pvt Ltd.: sales tax, VAT tax, value-added tax, memorandum and article association of company etc.
An additional type of credit facilities provided by Banks
Personal loans are mostly unsecured in nature as they do not require any collateral security such as car or residence. These are used by people for small purposes. Their unsecured nature makes them attractive to the buyer.
Motor vehicle loan
The bank supplies different types of loans for purchasing a vehicle. Eligibility criteria are determined after reviewing the applicant’s history and repaying capacity.
Bank overdraft is an extension of getting a loan when the deposit reaches to zero. An overdraft allows the borrower to get a loan even if the account balance reaches zero. The interest rate to overdraft is high as compared to the other loan.
Education loan gives an opportunity to students for taking the loan if a student meets the eligibility criteria for getting a loan. Eligibility criteria depend upon the student’s college profile, ranks, marks etc. This gives an opportunity for the student to focus on and continue their studies.
This type of loan is provided by banks to the person who suffers from health-related issues. This type of loan is given by reviewing the personal capacity to pay loans and after considering the financial situation of a person irrespective of a medical problem.
With a stable income and good credit history, there is also the availability of credit card, the creditor issuer will review your ability to get credit and decide whether to accept your application and creditor will also set a limit how much a person can take credit. Credit cards are used to purchase various items, different credit cards have different interest rates.
Essentials of Loan Agreement
The fluctuation of interest clauses
This clause gives permission to the bank to alter the rate of interest. When a customer takes a long term loan such as for 10 or 20 years then, the banks may alter the interest rate.
Default clauses of the loan agreement
Default is an occurrence of an event which the lender seeks protection against. The borrower will generally be allowed to seek protection against i.e grace period in which to cure the default and in case the borrower is not paying that on that period then it will create a certain contractual right for the lender.
This clause means security or collateral on the basis of which the loan is given. In case the collateral is insufficient, then the lender may ask for additional collateral security.
This clause is very important for banks. It gives protection to banks in case of a breach on default of non-payment by the party.
This clause gives a right to the bank to amend any of the clauses of the loan without informing the borrower.
This clause gives responsibility to the borrower in case of a change in address, residence and change in the level of income. These details should be informed to the bank during the tenure of the loan.
A credit facility is a type of advance given by banks for a certain period of time. There are various types of credit facilities such as retail credit facilities, loan facilities and letter of credit. Personal loans and credit card facilities are available depending upon the financial condition of borrowers. A creditor facility agreement provides responsibilities of borrower like loan interest, default, loan amount, security clauses etc.
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