Last Updated on December 6, 2021 by Admin
Different types of loans are available for various business purposes from banks, NBFCs and financial institutions. One should understand the basic concept of various categories of loan options so that they can choose best business loan option suitable to their business. Here is the basic overview of various financial instruments.
Table of Contents
Cash Credit Limit
Cash credit limit is provided by the banks on the basis of stock and debtors as primary security to the bank. It is a short-term loan or credit facility sanctioned by bank to its customers for 12month, which is renewable every year after 12 months subject to fulfillment of their terms and conditions.
A CC limit or cash credit limit allows customers to use the money for day to day business or working capital requirements up to the approved CC limit even if there is no positive balance in the account.
Suppose bank sanctioned Rs.10Lac as cash credit limit, then customer can use or withdraw the maximum amount of Rs.10lac for their business purposes at any time during the period. Borrower has to pay interest on utilized amount only on monthly basis to the bank. Interest is calculated on daily overdrawn/outstanding balance and debited to the cash credit or CC account on last date of every month.
Whatever amount you deposit into the cash credit or CC account, you can withdraw it again subject to maximum limit provided by bank. This facility is also called revolving credit facility.
Bank overdraft (OD) loan facility
Bank Overdraft (OD) bank account is a loan account in which customer can withdraw amount even if there is no fund in your account. At any point of time amount can be overdrawn subject to sanctioned limit say upto 10Lac or Rs.1Crore.
Bank charge interest only on the amount used as OD loan in bank account on monthly basis. Interest is payable within seven days by the end of every month. OD limit is approved and set by the banks on the basis of value of assets provided to bank as security against OD loan by the applicant.
Banks generally evaluate the assets of business then given OD loans on certain percentage of value of those assets decided by the bank.
Difference between CC limit and OD limit
|Cash Credit Account||Overdraft Account|
|CC limit loan is provided by banks on the security of stock in trade and sundry debtors outstanding in business as primary security. But Bank may ask additional security if needed.||OD loan limit is sanctioned by bank on the basis of secured fixed assets of the business as primary security.|
|CC limit is allowed as a percentage of sundry debtors outstanding and stock in trade on monthly basis. For example, a bank may allow cash credit limit up to 80% of stock and sundry debtors outstanding every month based on financial data submitted by the borrower||OD loan is approved on the basis of market value of the property & other fixed assets which are offered as a security of loan to the bank. Banks do the market evaluation of those assets to arrive at the current value of those assets|
|Drawing power limit specified by the bank on monthly basis.||There is no drawing power limit. Borrower can withdraw money maximum upto OD amount approved by the bank|
|Monthly Stock & Debtors outstanding statement is required to be submitted to the bank on monthly basis to set the drawing power in CC account every month.||After approval financial statements are generally not required to be submitted to bank.|
|CC limit should be used for day to day working capital requirements of the business only.||OD limit can be used for any business purpose but not for speculation or illegal activity.|
|CC limit depends upon the monthly value of stock in trade as well as sundry debtors’ outstanding amount||There is no monthly reduction in amount of overdraft. OD limit is evaluated on yearly basis by the banks|
|CC limit rate of interest is lower than OD limit.||OD limit interest rate is higher than CC limit.|
Points to be considered while taking a CC or OD account facility
- Rate of Interest – Rate of interest is higher than fixed loans like Loan against property (LAP) therefore if you generally don’t have extra money to park in cc or od account then you should opt for LAP.
- Processing fees – Normally banks charge processing fees @ 0.50% to 2% on the sanctioned loan limit but that can be negotiated on case-to-case basis with bank.
- Minimum usage condition – Few bank levies charges if the cc or od account is not utilized upto a certain limit. For example, you take an OD account of Rs.5 lakhs and average use during the year is not 30% i.e. Rs.1.5 lakh then banks may levy charges for under utilization of loan limit.
- Loan foreclosure charges – This needs to be checked before taking any OD or CC limit that whether bank put any foreclosure charges if you want to close the account early.
- Interest payment clause – Normally banks require the customers to deposit the interest of the month in the bank account through cash or cheque deposit within seven days from the close of every month. If there is default then they may charge extra interest and penalty for the period of default.
Business Term loan
There are different types of business term loans which are provided by banks for various business needs such as to purchase plant & machinery, equipments, inventory, or other goods, for expansion of business operations, to inject cash for working capital requirements, to manage new projects, to buy office space/land or building, to pay salaries to employees; to pay rent or to manage other operational expenses etc.
The repayment term for business-related term loans can range from 1 year to 7 years.
Different types of business loans: –
Working capital loan:
Small Industrial Development Bank of India (SIDBI) and other banks provide working capital term loan to business units for the purpose of day to day working capital requirements. Lenders usually take mortgage of current assets as well as fixed assets of the entity and working capital term loan is disbursed as per the requirements of the entity.
Normally financial institutions provide moratorium period of 12 months to 18 months to repay the principal amount of loan depending upon tenure of the loan. During the moratorium period, borrower is supposed to pay monthly interest due on the outstanding loan balance on monthly basis.
After the moratorium period is over, loan monthly EMI is started till the end of tenure of loan as per agreement.
Plant & machinery (equipment) financing:
This is asset specific loan provided by the banks/financial institutions to the entities to buy the plant and machinery or equipment for their business. Borrower need to submit the suitable quotations from the seller of such equipment or plant & machinery to the banks to start the process of loan to the borrower.
If the borrower fulfill all the terms and conditions related to loan then normally banks issue bankers cheque or transfer payment directly to the bank account of the seller so that they dispatch the material to the borrower and then borrower is supposed to submit copy of invoices to the bank after receipt of such material to their site. Normally banks provide this type of term loan for 2 to 5 years tenure.
Project finance is taken by the entities either to start new project or to expand the existing project. Borrower is supposed to submit their project report along with financial statements and other documents to justify the cost of project and means of finance etc.
Banks and financial institutions do detailed studies on the project report and other related documents submitted by the borrower, they see the viability and market future of those project and also check the networth of the borrower, collateral security etc. to decide the amount of loan for such projects and it may take time for approval of project finance depending upon amount of loan requested by the borrowers.
Loan against property:
Loan against property (LAP) as name is self-explanatory, this kind of loan is provided against some house property or commercial property by the bank. Lenders normally check and verify the ownership and realizable value of the property and if everything is to their satisfaction then they sanction the loan in few days.
If borrower make any default or fail to repay the loan then lender has legal right to seize and sell that property and recover their money.
LAP is very popular mode of loan for quick finance from the banks as banks normally do not take much time to sanction the loan and normally they finance 70% to 80% of total value of the property as advised by their empaneled valuers.
Features of Term Loans
- Term loans can be categorized based on various factors and you can select what type of loan you wish to take based on your requirement and eligibility.
- A repayment schedule and interest rate will be associated with every term loan.
- Many lenders provide instant pre-approved loans which take few minutes or few hours to get disbursement of loan to bank account.
- The interest rate of term loan may differ customer to customer.
- The lender determines the requirement for security.
- Bank may ask for third-party guarantee in addition to collateral security in some cases.
- The loan repayments must be made in equated monthly instalments over the pre-determined loan tenure.
- The bank may apply several fees and charges to every loan.
- There may or may not be the option for full/part prepayment.
- Some loan types and lenders may levy a penalty for prepayment of loans.
Eligibility for getting Loan from bank
The eligibility criteria to get a loan varies based on the type of loan you are looking for. In general terms, you may consider the following criteria to check your eligibility.
- Good CIBIL score
- Consistent income or revenue from business
- Good networth with few assets such as FDs, investments, immovable property, etc.
- Sound debt repayment history for any loans taken in past.
- If you use credit cards then good history of the same will also help in getting fresh loan
Documents required for bank loan
Following basic documents are required in case of self-employed applicants
- Application form with photograph
- Identity and address proof
- Last 6 months’ bank account statement
- Proof of business
- Business profile
- Income Tax returns (self and business) for the last three years
- Profit/loss statements and balance sheets of the last three years
- Project report or proposal for loan
Advantages and disadvantages of Term Loan
Benefits of taking term loans
- Term loans are negotiable, you can negotiate with bankers for the interest rate, tenure, repayment schedule etc.
- Interest rate is lower as compared to other loans like personal loan or any other type of business loan
- Interest paid towards term loan is deductible expense in business entities and they can get benefit of tax reduction due to interest expenses
- Since they are secured loan and lenders don’t have high risk of any default in such loans because they keep adequate collateral security according to the loan value
- Borrowers are given option to close the loan prior to their maturity. After fulfilling certain conditions, banks normally do not charge foreclosure charges from their customers.
- Borrowers are provided repayment schedule of such loans so that they may pay the monthly EMI regularly without any default.
- Normally term loans are provided on fixed rate of interest by the bank so the borrower don’t have risk for increasing the rate of interest by the bank at any later stage during the tenure of loan.
Disadvantages of term loans
- The lender will be the ultimate authority to decide the loan amount they wish to offer to their customers based on several factors, such as repayment capacity, income, and others
- Since term loans are based on collateral security, lender has full legal right on such assets and properties to sell and realize their money in case of any default by the borrower of term loan.
- The lender imposes restrictive on entities, such as not to open bank accounts with other banks, they usually ask their customers to credit all their sales or revenue receipts to their bank account only. Lender may ask financial statements of the borrower time to time.
- Repayment of loan has to be done strictly as per schedule irrespective of financial position of the entity.
- All terms and conditions of term loan may not necessarily be in favor of the borrower.
Please also read relevant articles:-
What is CIBIL Score or credit score? How CIBIL Score is important for getting loan or credit card?