What is a Business Loan and How Does it Work?

If you intend to grow your business or manage cash flows better at some point during your business operation, a business loan can be of help. It is particularly important to understand what exactly this means in the Indian context and how it works before diving into any approvals or applications. 

This article simplifies what entails and encompasses a business loan for you.

What is a Business Loan?

A business loan is essentially funds offered by banks, financial institutions, or any private lender that one can use to finance business activities. Like most loans, you will be expected to pay it back with an interest over an agreed period of time. If you’re Googling “what is business loan, " you should know that these loans can help you expand your business and purchase inventory. 

In India, it is common to find business loans offered by banks, non-banking financial companies (NBFCs), and online lenders. The terms and conditions may differ, but the fundamental concept remains the same – you borrow a certain amount of money, which must be paid back with interest.

Types of Business Loans Available in India

1. Working Capital Loan: If you need funds to cover day-to-day operational costs like salaries or purchasing raw materials, then working capital loans are the best option for you. This is because they are usually short-term loans.

2. SME Loan: Meant for small and medium-sized businesses (SMEs), this type of loan is aimed at fostering growth among small enterprises. Often, they carry lower interest rates and require less paperwork.

3. Equipment Financing: You can take such loans to buy equipment or machinery. This is because the equipment serves as security for the loan.

4. Invoice Financing: If you have unpaid invoices, you can get them financed to ensure cash flow continues.

5. Term Loan: This is the most common type of business loan where you are given a lump sum amount upfront. It is then paid back in monthly instalments over an agreed period. Typically, these are used for long-term investments such as purchasing machinery or expanding operations.

How Does a Business Loan Work?

Here is the typical process that tends to happen most times:

1. Application: Initially, an individual applies for the loan by submitting essential documents such as his financial statements related to business, income tax returns, etc.

2. Eligibility Check: This involves checking whether the business qualifies for credit through aspects like credit score, financial status, and commercial background by a lender. Many Indian lenders will also look at your GST returns.

3. Loan Approval: If you meet certain requirements set out by the lender, your loan may be granted, and funds may be deposited into your company account upon completion of other necessary steps.

4. Repayment: Upon receiving funds, start making monthly payments consisting of advanced principal sums and accrued interests.

5. Interest Rates: In India, nominal loan interest rates start from 10% to 18%. These rates are determined based on a person’s creditworthiness, loan amount borrowed, and lender’s policy, among other things.

Key Factors That Affect Your Loan Eligibility

Several factors determine whether one qualifies for a business loan in India:

1. Credit Score: The odds of getting approval for a loan increase with a high credit rating. Anything above 750 points is considered excellent by lenders countrywide.

2. Business History: Lenders love seeing records of constant operations done by borrowers seeking money from them. If it’s been around for at least some years, then chances are they will get their way through application procedures without much hassles.

3. Annual Turnover: Your income generation capacity also influences loan qualification decisions. Generally speaking, higher turnovers equal more chances of securing funds.

4. Collateral: Some types of loans, like term loans, may require collateral such as property or equipment.

Benefits of Taking a Business Loan

1. Flexible Usage: Funds can be used for business purposes, including expansion plans, machinery procurement, and day-to-day operations.

2. Tax Benefits: Entrepreneurs can claim interest on business loans as an expense during income tax computation. You can use an income tax saving calculator to calculate the amount you will likely save.

3. Improved Credit Score: Timely repayment may help boost your business’s creditworthiness, making it easier for you to access other loans in the future.

4. Access to Funds: Business loans offer an easy way of obtaining funds necessary for the growth of your businesses. They can also aid in bridging temporary financial gaps within them.

How to Choose the Right Business Loan in India?

Here are some tips to help you choose the right business loan for yourself before applying.

1. Interest Rate: Always compare interest rates from different lenders. Lower interest rates mean you will pay smaller amounts over time.

2. Repayment Terms: Ensure the repayment plan is in line with business operations. Some financial institutions provide flexible repayment schedules so that you can repay using the earnings from your business.

3. Processing Fee: Before taking out a loan, it is always advisable to check for any hidden fees.

4. Loan Amount: It’s important to know how much money you need before borrowing. Only borrow what you can afford to repay without straining yourself financially.

The Bottom Line

A business loan might turn out to be a game-changer that will help you get capital for expansion or handle day-to-day operations better. Therefore, whether the purpose is for growth, buying equipment or just meeting short-term needs, choosing carefully while taking out such credit can make all the difference. 

If you are uncertain about how a business loan affects your tax liability, use an income tax saving calculator to gain better insight into potential savings and budget. Make informed decisions and choose the right loan for yourself.