At some point in their lifetime, pretty much every business will need to obtain some form of borrowing or commercial financing. Whether it’s a start up loan or refinancing in order to expand, some well handled borrowing can help a business soar.
However, the nuances and intricacies of business lending and small business loans can be a bit confusing. There are many different types of business loans or commercial loans available and they all have a time and a place and unique pro’s and con’s. In this post we will look at 5 common types of business lending, how these different types of business financing operate, and when each one may be useful for a business.
A business working capital is the difference between a company’s current assets and current liabilities. For example, if a business has cash reserves of $50k, equipment worth $30k and debts of $60k then its working capital is $20k.
Working capital offers a snapshot of a business liquidity and immediate financial health. A negative working capital (ie, where debts exceed assets) is obviously concerning whereas a positive ratio suggests that a business can service its immediate obligations. That said, an excess surplus of working capital can also be a sign of too much inventory or even missed investment opportunities.
A business overdraft is a semi-formal line of credit offered on a business banking account. Whenever a business opens a bank account, the bank will offer an overdraft limit which allows the business to spend more cash than it currently has.
Business overdrafts are usually limited to relatively low amounts based on a percentage calculation of the business typical cash flow but they can usually be extended relatively easily. A business overdraft facility can be very useful to help a business with temporary cash flow issues such as an especially rough trading month, or having to pay an unexpected cost.
However, the interest rates and fees applied when an account is overdrawn can be quite high and as such, it is vital for a business not to rely too heavily on its overdraft, and to return to a credit balance position as soon as possible.
There are 2 different forms of Asset Finance. One is where a business offers up an existing asset (such as equipment, property or shares) in order to secure further lending. The second form is when a business obtains a loan in order to acquire a new asset and then asset then forms the security for the loan.
Because asset finance is secured by way of collateral, the interest rates can be relatively low. However, if a business defaults on its payment terms or if the loan is suddenly called in, the lender can seize the asset. If the asset is a vital piece of equipment, this can put a business into an extremely difficult position.
A business bridging loan is basically a temporary, short term loan that is obtained to help a business when it needs to secure financing in order to purchase new assets, fast. Usually, the asset which the loan is used to buy will be taken as collateral for the lending.
Bridging loans are usually offered as a stopgap before more favourable lending can be arranged. As such they tend to come with relatively high interest rates and with short repayment terms. Whilst bridging loans are very effective, short term solutions, problems can arise if the business then fails to secure the necessary refinancing in order to repay the bridging loan.
Unique to the Australian financial market, a caveat loan is another form of short term lending which is secured against property owned by either the business, or the directors.
A caveat loan is kind of like a secured loan or a remortgage in that it means the lender can repossess the property in the event of a default. The difference however is that ‘the Caveat’ can be lodged against the property title very fast meaning a Caveat Loan is a lot quicker to arrange than a proper remortgage.
Like with bridging loans, the interest rates can prove high and repayment terms short so most businesses do look to repay caveat loans with formal remortgages as soon as they can.
Final Thoughts On The Types of Business Financing and Commercial Loans
In conclusion, not all small business loans are alike. There are, rather, many different types of business loans and diverse lines of commercial financing available. All have their own best uses and all have their own risks attached. Still, a savvy business can explore their credit and lending options and take full advantage of them in order to help it meet its goals.
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