Definition of Commercial Loan
Commercial loans are debt obtained from a financial institution to fund any capital expenditure or operational expenses or pay off another existing loan or expand the operations of the entity, and non-availability of such funds may paralyze either the growth of the operations of the entity.
How does it work?
- Commercial loans are provided mainly to cope with short-term funding needs and, in some cases, to fund capital expenditure.
- You got to make an application to the banker along with a set of documents such as the financial statements, personal details, qualification details, etc.
- The business needs to provide collateral which may be in the form of a bond or property of the business or major plant and machinery or stocks of the Company. Collateral is helpful for the bank to recover the dues in case of long pendency or default.
- Then the rate of interest becomes a part of negotiation depending on your risk profile, quality of the collateral asset, financials, repayment status of past loans, and a few other factors which may vary from one lender to another.
Types of Commercial Loans
Below are the different types of Commercial Loans:
|1. Equipment Finance||
|2. Money loan||
|3. Blanket loan||
|4. Business credit card||
|5. Line of Credit||
|6. Property loan||
Eligibility for Commercial Loans
- Private bankers generally provide commercial loans. The first and foremost requirement is that the borrower should have a good credit score (say 680+).
- The balance sheet and statement of profit and loss account need to be strong. Each lender has criteria for the amount of revenue. If your business qualifies for that criterion, you would be eligible.
- Collateral is required to secure the loan. The value of the collateral is dependent on the amount of loan required. Generally, the value of collateral should be at least 60% of the loan amount. Still, this figure varies from a case-to-case basis and from one lender to another.
- Bankers also see the number of years the company has been in the business. Generally, a minimum of 2 years of business history is required.
Why the need for Commercial Loans?
- A commercial loan may be required for purchasing new machinery for the business.
- It may also be required for upgrading the existing business facilities or buying new property.
- It may be needed for further expansion of the business at various sites or for setting up a new plant.
- The company may also need funds to invest in the new product line.
Commercial Loans for Small Business
- Small businesses are restricted from arranging finance through the bond market and equity market. Thus, they cannot raise finance directly from the public. Commercial loans come to the rescue with a higher upfront cost.
- Proprietary firms and partnerships prefer commercial loans due to ease of availability and lower documentation. In addition, since collateral is already provided, there are lower challenges in approving such loans.
- These loans are characterized by lower repayment duration. However, you can choose the repayment method at your convenience.
Advantages of a Commercial Loan
- The application process is simple and easy to use.
- There are no regulatory hurdles like equity markets.
- The cost of finance is lower than raising funds through equity markets.
- A commercial loan takes the form of additional cash or capital. The entity can decide on the usage.
- Commercial loans are normally short-term and hence do not dilute the debt-equity ratio of the entity.
- The lender may extend the loan period in special circumstances. This helps businesses to plan the revised budgets.
- Commercial loans are structured as per the needs of the borrower.
Disadvantages of a Commercial Loan
- The business should have a sufficient stream of consistent cash flows so that none of the EMI payments is missed. One such event is enough to jeopardize the credit image of the entity.
- Since the process is majorly online, it requires a high quantum of documentation.
- In case of consistent defaults, the banker has the right to confiscate the equipment or property. In addition, the banker may auction the property in extreme circumstances.
- Debt is a double-edged sword. If used abruptly, it can make the business go bankrupt.
Key Takeaways for Commercial Loans
- Bankers provide these loans to cope with the short-term financing needs of any business.
- It requires collateral which may be equipment or property, or machinery used in the business.
- A set of documents such as bank statements and financial statements are required to be submitted to the bankers.
- The rate of interest depends on various factors such as the creditworthiness of the borrower, nature of the business, and business history.
- If required, bankers may renew or extend the loan period.
Commercial loans are a medium for any small business to expand or grow its operations. If these facilities are used wisely, the business can grow to all possible extents. However, sufficient care should be taken not to overuse commercial loan facilities. Excess dependency on outsider funds may be harmful to the organic growth of the entity.
This is a guide to Commercial Loans. Here we discuss the definition, working, and types of Commercial Loans along with their advantages and disadvantages. You may also have a look at the following articles to learn more –