A Guide to Business Loans for SMEs

14th Apr, 2021 | Articles

In this article:
Know all about the different types of business loans, lenders' eligibility criteria and what to keep in mind while looking for a suitable fit.

As the name suggests, ‘Business Loans’ provide finance for a range of business needs. The right business loan can make a massive difference to your business by providing you with the necessary capital for upscaling, innovation or even managing cash flow during challenging times. While the business loan landscape is quite complex, we’ve attempted to capture the fundamental essentials we believe every existing and prospective business loan applicant should be aware of.

Types of business loans

There are multiple kinds of loans to address almost every business need. Here’s the most common classification for business loans

1. Secured and unsecured

Loans: Secured business loans require an asset like a vehicle or property as security. Unsecured loans, on the other hand, don’t need any asset as collateral. On account of being considered less risky, secure loans usually have a lower interest rate and less stringent eligibility criteria. 

2. Fixed-Rate and Variable

Rate: Fixed-Rate loans have an interest rate that doesn’t change for a fixed period. With a variable rate business loan, the interest rate changes as per market conditions. Fixed-rate loans offer stability, while variable rates have the advantage of you benefiting from a drop in interest rates.

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3.  As per business needs: As mentioned above, business loans are designed to address the entire spectrum of business needs. Some common needs that business loans address are as follows.

  • Line of Credit: With this kind of loan, you have an upper limit on how much you can borrow, but the lender charges you interest only on the sum you borrow. Here’s an example for clarity. Let’s say you have a line of credit of $50,000. This means that you can borrow up to $50,000. You, however, borrow only $20,000. In this case, you’ll be charged interest only on the amount you borrow, i.e. $20,000
  • Invoice Finance: This is typically a loan to cover you until you receive payments from your clients. The loan amount you can borrow is usually a percentage of the total invoice amount you are due to receive.
  • Merchant Advance Finance:  Also known as trade finance, this is a loan to finance payments to vendors to purchase inventory or stock needed for your business. 
  • Equipment Finance: Such a loan is specifically designed to purchase equipment and machinery and is one of the most common types of loans among SMEs (Small, medium enterprises).
  • Business Credit Card: Like regular credit cards, a business credit card usually has a 55-day interest free period. This is one of the most popular forms of short-term debt for small businesses.

Requirements for a Business Loan

While examining your suitability for a business loan, lenders take into account

  1. The profitability of your business
  2. The turnover/revenue of your business
  3. How long ago was your business established
  4. The credit score of your business – how timely you’ve been with payments, your current debt and business expenses
  5. The purpose of the loan

In terms of documentation, lenders usually require:

  1. Proof of Identity – passport, driver’s license etc.
  2. Business Activity Statements (BAZ) – these typically include Balance Sheet, Income Statement, Cash Flow Statement and Statement of Retained Earnings
  3. Personal Income – tax returns
  4. Bank statements – to access your financial situation
  5. Business plan – this is usually required for newer businesses and start-ups to establish the approach for day-to-day operations  as well as potential growth

Things to be mindful of while applying for a business loan

  1. Fees: on account of being complex, there are many charges associated with a business loan. Be sure to understand the actual cost of your loan.
  2. Loan Features: Benefits like an offset account, redraw facility and the flexibility to make larger and frequent repayments can be crucial in paying off your loan faster.
  3. Turnaround time: If  your business is in dire needs of funds urgently, it’s necessary to go with a lender that can assist in a timely manner.

Business loans are complex, and selecting the right loan requires consideration of multiple factors like collateral, fixed versus variable rate, loan tenure, and turnaround time to name a few. It’s best to rely on a mortgage broker for professional guidance. Lenders pay brokers upon settlement of a loan. Broker services are, therefore, usually free for borrowers. A broker will not only scope the market to find the right option for you but will also handle all the loan paperwork, and keep you posted at every step of the application process.

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The information is a compilation from various sources for your benefit and should not be relied upon in lieu of appropriate professional advice.