3 Types of Business Loans - Which Should You Choose?

Mar 06, 2017

Every business owner wishes to expand his business. Sometimes entrepreneurs require urgent funds for the smooth functioning of their business activities. Such finance may be obtained through external sources such as banks or Non-Banking Financial Companies (NBFCs).

The amount borrowed may then be used for numerous purposes, to start new ventures, to fund working capital needs, to conduct research and development for further growth and expansion of business.

Before applying for a loan, it is beneficial to know the various types of business loans available. Knowledge of the types of loans helps you make a well-informed borrowing decision. Following are three types of loans commonly available to business owners.

1. Term loans

Term loans are the most common form of loans for business purposes, and hence there is a huge demand for such loans. In this type of loan, you may borrow a certain amount, usually for a specific purchase you make for the business and then repay the amount over a set term, which is usually at a fixed rate. Nowadays, due to flexible repayment schemes offered by numerous lenders, you may borrow a term loan and then repay according to your business' cash flow. If you wish to pay an advance amount towards the loan, in the case of a large turnover, you may do so. Prepaying a huge amount significantly reduces the outstanding loan amount.

2. Overdrafts

Overdraft is a temporary form of financing which allows you to borrow an amount beyond the funds available in your current account. If the amount overdrawn is higher than the limits of the prior agreement, the financier levies a higher interest rate. It is advisable to overdraw within the limits set, so as to avoid high rates. This form of financing is ideal to meet your temporary finance needs.

3. Working capital loans

You may avail of a working capital loan to meet the expenses associated with the daily functioning of the business. A working capital loan helps to finance everyday expenses like office rent, payroll, and debt payment. It is also used to cope with seasonal dips in revenue and to ensure smooth inflow of inventory. Availing of a working capital loan offers you the flexibility to invest in your company's growth. It also provides a reserve to cover day-to-day business expenses. Lenders generally offer low interest rates on working capital loans if you own an established business with a strong cash flow.

You may borrow any one of the aforementioned types of business loans based on your company's requirements. In case you wish to obtain cash on a temporary basis, overdraft is the best solution. If you are borrowing a huge amount, then you may opt for a term loan as such loans are usually repaid over a longer duration. You may borrow a working capital loan if your business requires funds for daily functioning.

It is imperative to understand the importance of having adequate funds for the smooth functioning of the business. In the absence of finance, business processes are adversely affected. It is, therefore, important to apply for a business loan at the right time.