Differences Between Loans and Advances
Loans and advances both bears the same property of raising money using some finance or debt instruments where loans are generally for a long term period and usually for a specific purpose whereas when an organization raises money to meet its short and very short term needs then it can be termed as advances received and the same can be used for general purposes in the company.
Money is an essential part of any business. Without money, it would be very difficult to run any business. Banks and financial institutes are the best way to raise funds for any business. Banks have many options for financing our business or project. Among them, Loans and Advances are the best options for business fund requirement which are very popular in the financing of the business.
What are Loans?
This is the best and very popular financial facility provided by a bank or other financial institutes to help businesses at the time of money requirement. Finance is the blood of any business. So, when it becomes difficult to arrange finance by the owner himself, then the businesses can use this option to arrange funds for their business. This financing option is provided for the long term. Loans are a type of debt and have a repayment schedule for a longer time duration.
What are Advances?
Advance is a kind of credit facility provided by banks or financial institutes for covering daily fund requirements or as working capitalWorking CapitalWorking capital is the amount available to a company for day-to-day expenses. It's a measure of a company's liquidity, efficiency, and financial health, and it's calculated using a simple formula: "current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)". When a business needs money to cover their daily expenses such as salary, wages, or purchasing raw materials, they can think over this kind of credit facility from the banks. It is a cheaper and convenient way of arranging short-term financeShort-term FinanceShort-term financing refers to financing a business for less than a year in order to generate cash for working and operating expenses, usually for a smaller amount. It include obtaining funds through online loans, credit lines, and invoice financing. as banks charge very low interest and charges on it.
Example of Loans and Advances
There is one company that is looking for external funds for its business as it became so difficult for the business owner to arrange funds from his personal sources. The business owner requires funds for two purposes,
- As working capital (for daily expenses such as salary, wages, raw materials, etc.) and
- For buying machinery for his business.
So, the business owner considers arranging funds from banks and other financial institutes. Let’s assume that the business owner approaches his bank where he has the firm’s current account.
Now the bank suggests two options to consider for funds, one is called Loan and the other is called advances which is credit facilityCredit FacilityCredit Facility is a pre-approved bank loan facility to businesses allowing them to borrow the capital amount as & when needed for their long-term/short-term requirements without having to re-apply for a loan each time. in nature.
- Bank suggests choosing a loan option for buying machinery because it requires a huge amount for buying machinery and business owner will be paying in longer duration. Bank will charge interest on that and some other charges would be included in the repayment schedule. This option is considered to be good when any business needs a huge amount for its business and that amount can’t be repaid in a shorter duration i.e. 6-12 months and loans would be paid in equal monthly installment. The pre-closure option is also available if the owner wants to close the loan before loan tenure.
- But for daily expenses, the bank suggests choosing advance credit option which is credit facility given by the bank to businesses where a business has to repay the outstanding amount in shorter duration. So Advance credit facility is for shorter duration i.e. 1-2 months. This is a cyclic process, once you repay the amount used as Advances, you can use the same amount for further requirements.
- A loan will be sanctioned and has to be repaid fully. When someone needs another loan for the same purpose, he has to repay the full amount with interest within a predetermined period.
- But on the other side, money taken as advance have to be cleared in one transaction with some small bank charges.
Loans vs Advances Infographics
Let’s see the top differences between loans vs advance.
- Basically, when businesses require huge requirement of money for business expansion, such as machinery, plant, building or any kind of investment that requires huge money, the loan is the best option, as it is not required to repay the loan amount in a shorter period of time. But when business is looking to raise funds for covering expenses for the shorter period, such as salary, wages, purchasing raw materials, or other office expenses, the advanced option could be considered as once the business gets money from sales, debtors or from any other sources, advances can be cleared off.
- Loans can be given as a personal loan, home loan, a mortgage loan to businesses or individuals as well, but advances are specially designed for corporates for a particular purpose. Advance can be issued against debtors or future sales as well.
- Loans are basically sanctioned for a longer period of time. Most of the time the repayment duration will be more than 5 years. But advances have to be cleared off within 1-2 months.
- Loans include interest part with repayment. Basically, interest is calculated on an annual basis, so if we take long tenure for loan repayment, we have to pay more interest on it. Advance is a kind of credit facility, we can compare it with a credit card for better understanding. In credit card, we can spend money and repayment will be done on monthly basis, same like that, advances also include some duration of clearing off, otherwise, other charges would be included with the repayment.
- The loan is given once for a specified purpose and has to be repaid fully before getting the second loan for the same purpose and on the same collateral. But advances are sanction as a Limit, and the amount can be used within that limit, and repay and drawing of the amount would be permitted within that limit.
- There are so many legal formalities in the process of getting off a loan. As it carries a huge amount of money, banks will check the purpose of the loan and the repayment capacity of business firms, as per the repayment capacity and previous repayment records, the bank will sanction loans to business. We have to provide various financial or non- financial documents to the bank to convince them about the purpose and repayment capacity of the firms. But in the process of advance, it requires less documentation and legal formalities.
- Loans can be secured or unsecured. But most of the time we have to put security as collateral for a loan if the loan amount is huge and the repayment tenure is also high. But for advances, we have to put security as collateral as well as a personal guaranteePersonal GuaranteeA personal guarantee is an agreement between three parties – lender, borrower, and guarantor, whereby the guarantor has legal binding attached to him to repay the lender and honour the loan agreement if the borrower defaults. of Directors. Banks also consider bills receivables, stocks, etc. as security collateral.
Loans vs Advances Comparative Table
|Basis of Comparison||Loans||Advances|
|Meaning||It a kind of financing facility provided by banks to business organizations or individuals for a particular period of time which is carrying the interesting part and other charges.||It is a credit facility provided by banks to business organizations where businesses need money for a short period.|
|Nature||In nature it is debt. Unlike other debts, it has to be repaid on an equal installment basis which carries interest part in repayment.||In nature, it is a Credit Facility. It has to be repaid in a single transaction within a particular period of time.|
|Repayment Duration||Long Term||Bridge to Short-term needs. Maximum for one year only.|
|Security as a Collateral||Yes, secured against collateral Security. Sometimes it can be unsecured also.||Yes, primary security and directors’ personal guarantee.|
|Legal Formality||There are various legal formalities as the amount is huge under this facility.||As compared, less legal formalities and documentation.|
|Monetary Value||It can raise a huge amount as the debt.||It provides less amount of money, usually, the 2-3 months of working capital could be raised.|
|Interest||Banks charge interest portion on it.||Most of the time, the interesting part is not available but we need to pay bank charges on it but that would be minimal in comparison.|
This has been a guide to Loans vs Advances. Here we discuss the top differences between loans and advances along with an example, infographics and comparison table. You may also have a look at the following articles –