Business Loans and Lines of Credit - Working Capital Loans

Business Loans and Business Lines of Credit.

These unsecured business loans are an excellent source of capital for your business regadless if you are just getting started or have been in business for years.

Business Loans & Business Lines of Credit

Business loans

are designed to help businesses grow or meet immediate needs. The idea is to get a large sum of capital now by leveraging future cash flow.

Let's say a business needs $100,000 in working capital now to fulfill a project for one of its customers. The business makes $20,000 a month in profits. Thus, the business could wait 5 months, save its profits and have the $100,000 needed for the project. But, the customer is asking for the project to be completed in two weeks.

The business could leverage both its monthly profits of $20,000 and its profits from this job and secure a small business loan or business Line of Credit for the $100,000. The business could make monthly payments on the loan - using its $20,000 monthly profits until the project is completed. Once the project is completed, it could pay off the loan; plus fees and finance charges, and realize the remaining balance from the project as profits. Not a bad scenario given the choice between accepting the project and its profits or rejecting the project due to limited cash flow.

Business Loans can also be taken out for inventory purchases, equipment and machinery, commercial real estate, to bridge a funding gap, for working capital, or for any realistic business matter.

Business Loans are usually term facilities; meaning that the original balance is paid down on a fixed schedule of both principle reduction and interest charges. Terms for loans are generally over one year in time and can be set up as interest only payments, quarterly payments, or balloon payments.

Business Lines of Credit (LOC) are similar to loans in that they leverage future cash flow to get needed capital now. However, LOCs are usually tied to specific events (e.g. working capital, inventory, operating cycle, etc.) and normally have a term of one year (12 months) or less. The idea behind a Line of Credit is to allow the business the flexibility to draw from the line when the company needs the funds and not have to apply for a new loan facility each and every time it needs working capital throughout the year. Thus, when projects materialize, the business can immediately get the funds it needs without having to wait weeks for bank approval.

Business Lines of Credit are usually asset based (e.g. tied to inventory or accounts receivables) and can fluctuate with the balances of these accounts.

Secured vs. Unsecured Business Loans

Secured Business Loans: A secured business loan is a loan in which the borrower pledges some business asset acceptable to the lender as collateral for the loan. Collateral for business loans come in all forms and shape from stocks, bonds, and other financial assets to inventory, property and plant and equipment and machinery. However, for the most part, loans are secured by the assets purchased by the capital from the loan.

The lender (bank, financial institution, or non-bank entity) is given security - a lien on the asset - until the loan is paid off in full. If the business defaults on the loan, the financial institution would have the legal right to repossess the asset and sell it to recover any outstanding loan balance and other charges.

Secured business loans are usually tied to the asset being purchased. If the purchase is a piece of equipment, with a useful life of five years, the loan term will usually be for the same five year period or less.

Unsecured Business Loans: Unsecured loans are monetary loans that are not secured by any business or personal asset. The most common type of unsecured business loans are business credit cards. However, business line of credit can also be unsecured as well as unsecured term loans with fixed or variable rates.

Interest and Fees

When financial institutions lend money, they take risks in doing so. Further, lenders put out a lot of effort in providing loans; from underwriting, auditing, and servicing of the facility to securing the capital from investor or depositors. For these efforts and its risk, banks and other financial institutions will charge booth fees and interest when making business loans.

Fees MAY come in the form of:

• Application fee
• Origination fee
• Monitoring fee
• Audit fee
• Appraisal fee (unless loan is unsecured)
• Monthly service fee
• Annual fee

In any case, the financial; institution is attempting to ensure that it covers its cost in providing these loans as well as make a tidy profit for its shareholders, owners, or investors - similar to what your business does when it sets its prices.

Interest can either be fixed or variable; but, are mostly variable. Interest rates are typically tied to some monetary measure like the LIBOR or Prime Rate (stated in percentages) - these are measure that financial institutions use to determine what their costs of funds are (i.e. their costs in getting the capital to loan to your business). Financial institutions usually add additional percentages points to the base measure. This additional increase in rate is usually tied to the riskiness of the borrower. Example: Prime + 2%. If the Prime Rate is 4% - the total interest rate is 6% (4% + 2%).

Expect variable rates to be lower at origination but have the possibility to increase substantially if market conditions warrant. Fixed rates, as the name suggests, are fixed over the life of the loan and usually start out much higher than variable rates but do not carry the same market risks. Example: Prime + 4% - fixed as opposed to Prime + 2% - variable.

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Purpose

Most financial institutions, especially banks, are very picky about the use of funds and collateral of the loan. Lenders want to protect themselves, their depositors and/or investors. To do so, they may restrict how the proceeds of a loan are used.

Obliviously, lenders do not want to lend to businesses that conduct illegal operations. Should the business get caught doing something illegal, the financial institution stands a very good chance of never seeing its money again.

In conjunction, lenders do not like to lend to borrowers who have shown in the past that they are not willing to repay borrowed funds. This is usually determined by examining a borrower's credit history.

Moreover, banks, during their underwriting, will determine, in their minds, if you or your business has the wherewithal to make the minimum monthly payments. If you or your business does not have the cash flow to make monthly payments, how can the bank be assured that they will get their money back?

What a lot of borrowers do not know or understand is that banks and other financial institutions are also picky regarding the collateral for secured business loans. Financial institutions like collateral that, in the event that they have to take ownership of the collateral, it is easy to dispose of. Banks are not in (insert your industry here) and thus do not really want to take ownership of collateral. If they have too, they want to be able to sell it ASAP for the best possible price. Bottom line here: If your collateral is very specific to your industry, the financial institution may find it harder to lend against it then collateral that is usable across all industries.

Repayment

Lenders typically like to see three (3) sources of repayment. The first and most important is cash flow - the profits your business generates in operation of the business. However, if the loan is tied to a financial assets like inventory or accounts receivables, the lender wants to see those assets converted to actual cash (cash flow into the business) as soon as possible. Second, is usually based on the collateral securing the loan. Lenders look for assets that have resell values that meet or exceed the amount of the loan. Should the loan not have specific collateral (like an equipment loan would) or is under collateralized, the lender will require a blanket liens against all the business' assets. As a third source, lenders typically turn to personal guarantees. This shows the lender that the business owners are willing to risk their own personal assets to grow the business. So, be willing to provide your potential lender with at least three sources of repayment - including a personal guarantee.

In regards to cash flow, it is not sufficient to have just enough cash flow to cover the payments of a business loan - both principal and interest - but to have a little bit more (as much as half more) - just in case your business has a slow period, it can still meet the minimum payment.

To determine if your business could service a $100,000 business loan, begin with your net income. To this amount, add back depreciation (this is a non-cash accounting anomaly) and any and all interest payments that you already make. This should be the net amount that your business has to cover your total debt service - we will call this amount your modified net income.

At 8% for 36 monthly payments, a $100,000 loan would require a monthly service of $3,134 or $37,608 per year. Assuming that your business does not have any other debt, you would have to, at the least, earn this amount over and above all other business costs (over total operating expenses). However, most banks want to see a debt service ratio of 1.5 X - meaning that you need to earn the payment amount plus 50% or $4,701 per month - to cover the loan payments.

The reason is to assure the lender that, should your business hit a small bump or down turn, your company would still be able to service the facility for the entire 36 months.

Small Business Loans and Business Lines of Credit

are great sources of working capital for new or growing businesses. These business loan types can be used for nearly any business purpose including (as stated) working capital, inventory, overheads and operating expenses. Unsecured loans are harder to obtain as they add additional risk to the lender. However, keep in mind that it takes money to make money and all businesses need capital from time to time!

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Please see each individual business's applications and guidelines for details about terms and conditions of offers. We take reasonable efforts to maintain accurate information. However the information presented is without warranty. When you click on the "Apply Now" button or company logo you can review the terms and conditions on the lender's web site in most instances. Simply clicking a link does not guarantee approval or acceptance in any program.