Accessing credit to expand or meet the critical needs of business is often essential for many business owners. However, choosing the right business loan is crucial for the financial health and long term growth of the business. One needs to understand and carefully evaluate business loan options based on factors like their costs, repayment structures and how they align with the financial and operational requirements of their businesses. Here are some of the factors that business owners should consider when selecting for the right business loan:
Assess the financial requirements of your business
Begin with comprehensively evaluating your business requirements. Doing so will help you in determining why you need the loan—is it for expanding your operations, purchasing new equipment or for managing cash flow.
For instance, for those planning to expand your business, the gestation period can differ as per the nature of your business. For businesses with a long gestation period—where profits take time to materialise—availing loan schemes offering long tenures, flexible repayment options and lower interest rates would be ideal. If the bulk of the capital allocation goes into purchasing stock-in-trade, inventories and raw materials or meeting short-term cash flow mismatches, then availing working capital loans like cash credit facilities, overdraft, bill discounting, etc. would be more appropriate.
Having a clear understanding of the current/near-term financial standing of your business can help you gauge your credit needs better.
Know the different types of business loan available to you
Every business is different, and so are their financial requirements. The structure of credit facilities may also vary depending on the operational requirements, conditions unique to industry/sectors and/or growth phases of the businesses. To meet these varied financial requirements, banks offer different types of business loans like:
- term loans
- overdraft facility
- professional loans
- bill discounting
- machinery finance
- purchase financing
- working capital loans
- bank guarantee
- letter of credit
- merchant cash advance, etc.
Besides these loan options, also consider exploring government-sponsored loan schemes like PM MUDRA Yojana, Stand-Up India, etc.
Before making any choice, understand what these schemes are, how they work and whether they meet financial or operation requirements of your business.
Check collateral requirements
Lenders usually ask for collateral from businesses to mitigate their credit risk. Collateral acts as a security cover for the lender to recover their money, in case of loan default. The collateral requirements would vary depending on the type of loan you wish to apply.
For instance,
- A manufacturing business can pledge its industrial property or equipment to finance their capital expenditure at competitive interest rates.
- A supplier business seeking working capital or liquidity can leverage its outstanding invoices with its clients by availing bill/invoice discounting from the lenders.
Thus, assess whether you have the qualifying assets to pledge and understand the risks involved. While unsecured loans are available, these are usually offered at higher interest rates, for lower loan amounts and for more simpler credit solutions.
Compare interest rates and other fees/charges
While evaluating different types of business loans, you must also pay close attention to the costs involved. Usually, these costs include interest rates, processing fees, prepayment charges and commitment fees (in case of credit limits).
As business loan interest rates primarily influence the total cost of borrowing, applicants must always look for the lowest possible rates. For this,
- First, check offers from lenders with whom you/your business already have deposit(s) and/or credit facilities.
- Then, visit online financial marketplaces like Paisabazaar to compare business loan rates offered by other banks and NBFCs for various business loan schemes.
- Additionally, you must consider the charges involved, which will affect your overall borrowing cost.