Commercial Loans Meaning
Commercial Loans are short term loans that are used to raise a company’s working capital, meet heavy expenses and operational costs. it is a kind of financing that is often used by small companies that cannot afford to raise capital from equity markets and bonds. Commercial loans are often provided by banks and well-established financial institutions against financial statements and credit score of the debtor.
Types of Commercial Loans
There is the various basis of its classifications like repayment term/time, lending authority, loan amount, etc. Let’s begin with the simplest version:
#1 – Term Loans
it is the most basic kind of loan that banks lend to business owners. And as the name suggests, it has a fixed term of repayment, interest rates, and maturity date. Usually, term loans with collateral carry lower interest points than those without collateral. It is because the risk without collateral is more for the bank. Classification based on the term is as follows:
|Short Term||Less Than 12 Months|
|Medium Term||More Than 12 less than 3 Years|
|Long Term||More than 3 Years|
#2 – Bank Overdraft Facility
Consider this, Betty needs to pay $150,000 immediately to her supplier. Her customer has promised to pay $180,000 after 3 days and she has only $10,000 in her bank account. The best course would be to go to her Banker and avail and Bank Overdraft facility for a $20,000 deficit. The biggest benefits of bank overdrafts include lower interest rates as compared to term loans and least documentation.
#3 – Letter of Credit
A letter of creditLetter Of CreditA letter of credit is a payment mechanism in which the issuer's bank gives an economic guarantee to the exporter for the agreed payment amount if the buyer defaults. In international trade, buyers employ LC to reduce credit risk. is a document issued by the bank to your supplier that guarantees him payment based on which he will supply goods to you. This is widely used on import-export transactions whereby the parties do not know each other.
#4 – Leasing
Leasing is a financing medium that allows companies or individuals to own specific assets for a particular period of time in return for interim payments. The asset reverts back to the lessor at the end of the leaseLeaseLeasing is an arrangement in which the asset's right is transferred to another person without transferring the ownership. In simple terms, it means giving the asset on hire or rent. The person who gives the asset is “Lessor,” the person who takes the asset on rent is “Lessee.” in normal circumstances unless mentioned in the agreement.
Points to Consider
- The process of availing of the loan, Guarantee from banks, Letter of credit is often time-consuming and with higher documentation costs. Some sources such as bank overdraft facilities require no or minimal documentation and less time-consuming. This streamlines the prospect of fundraising as per the company’s requirement.
- It is crucial to think about a strategic partner for advice on various business operationsBusiness OperationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation., markets, etc. In case you do, then VC or PE is a better choice. If you just need money, then commercial loans are the way forward.
- When you default in repayment your credit rating reduces. Its adverse effect would be felt when you go for the next round of finance as the terms of the loan would change.
- A company that frequently borrows may not reap many benefits to its shareholders. In a monetary aspect, EPS reduces.
- In recent years, many companies have gone bankrupt because of their inability to pay the debt raised by them. The appraisal of the entity in this aspect is essential.
This has been a guide to What is Commercial Loans and its Definition. Here we discuss the commercial loan types along with advantages and disadvantages. You can learn more about it from the following articles –