What to consider before taking a business loan?

In the unpredictable business environment, it is essential to thoroughly assess various factors before pursuing a business loan. Ensuring that the credit aligns with your business needs and financial capabilities is crucial. Here are the key factors to take into consideration.

What to consider before taking a business loan?

Monday February 12, 2024,

4 min Read

In the face of adversity, business loans serve as crucial lifelines for maintaining cash flow. Yet, for small and micro enterprises (SMEs), securing credit demands a meticulous approach to avoid lurking dangers such as Non-Performing Assets (NPAs). According to an RBI report, gross NPAs from banks stood at Rs 5.7 lakh crore as of March 2023.

In the uncertain business ecosystem, before proceeding with a business loan, it's crucial to carefully consider several factors to ensure that the credit aligns with your business needs and financial capabilities. Here are the top factors to consider. 

Purpose

Clearly define the purpose of the loan. Whether it's for working capital that helps businesses manage their everyday operations and improve cash flow or equipment or asset purchase, expansion, or other specific needs, having a precise plan helps in selecting the right type of loan and tenure. 

Maintain a strong balance sheet

The financial health of the business plays an important role thus, before seeking business loans ascertain the funds you have in business so that you don’t miss an EMI if a challenging period arises. 

During a conversation with SMBStory, Suresh Mansharamani, a business coach and founder of Tajurba, a prominent business networking company in Gurugram said that traditional banks usually hesitate to give loans to small and medium businesses fearing NPAs as these enterprises as well do not focus on building a strong balance sheet.  

Hence, maintaining financial health and also accessing the credit score is important as lenders use these scores to evaluate the risk of lending to you. Higher credit scores generally lead to better loan terms, such as lower interest rates.

Eklavya Gupta, Co-Founder of Recur Club, a trading platform that enables companies with recurring revenues to raise non-dilutive growth capital upfront instantly says that getting the right loan at the right time can really make or break a business's growth. Thus, the speed of receiving funding, guidance from capital experts, and flexible repayment terms are crucial factors when securing business loans.

Documents and collateral

Ensuring accurate documentation is crucial when applying for a business loan in any industry. As a micro or small business owner, it's essential to have all necessary documents prepared, including collateral if required. While collateral loans are generally not recommended for SMEs due to their limited scale, if you decide to pursue one, exercise caution and remain vigilant about repayment terms.

Secured or unsecured loan

A secured loan necessitates borrowers to provide collateral or security as a guarantee for the loan, whereas an unsecured loan, typically of short-term duration, does not require such collateral. Obtaining an unsecured loan has become more accessible for small businesses with various fintechs, NBFCs, and microfinance companies in the ecosystem. 

However, Mukesh Mohan Gupta, President of the Chamber of Indian MSMEs, pointed out in a discussion that these unsecured loans are usually short-term, lasting a maximum of 2-3 years or even shorter. While these loans are customised to meet the specific needs of each company, the challenge arises for small businesses that require working capital for business expansion. Repaying unsecured loans within a brief timeframe, particularly with high-interest rates, can pose difficulties for these businesses.

Interest rate

Business loan interest rates from public banks like State Bank of India and Punjab National Bank generally range from 9% to 13% annually. In contrast, private banks such as HDFC Bank and IDFC Bank offer interest rates spanning from 10% to over 25% per annum, depending on factors like tenure and business type. For fintech, the interest rate may also go up to 36%. SME owners need to be cautious about where they are borrowing money.

As an alternate source, the SMEs could also explore various government schemes like PM Mudra Yojana or Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) scheme, etc. 

The copy was updated to fix a style error


Edited by Affirunisa Kankudti

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