How business loans can be used effectively?

Business loans are sought by a business to satisfy the working capital, operational, administrative, and CAPEX needs. The funds are required for the smooth running of the business when you can’t rely on your internal finances all the time. Working capital loans, cash credits, overdrafts, letters of credit, invoice financing, term loans, and machinery loans are some of the types of business loans.

 

The tenure of repayment varies between 3 months and 5 years and it depends on the type of loan. Even the tenure of a long-term business loan does not exceed 10 years. The interest rates can range from 8% to 36%. The credit score, credit history, standing and viability of the business, and relationship with the banker are all considered by the lender while sanctioning a business loan.

 

Once a business loan is sanctioned, the next important question is how to use it effectively. Here are a few pointers that would help in the efficient utilization of business loans.

 

How to use the business loan?

Business loans are always demand-specific. Lenders always look for the purpose for which a loan is sought. For example, a cash credit loan though a term loan is a working capital loan. 

Overdraft facilities are only extended for working capital needs like purchasing raw materials, paying your operational creditors, etc. Business financing is quite costly and hence a detailed utilization plan can help to avoid financial surprises.

 

As to how a repayment plan is drawn for a loan, a clear spending plan must also be prepared. 

  • The purchase of raw materials, consumables, and other manufacturing expenses shall be given priority in spending over any expenses.
  • If you have got a term loan to replace your existing machinery. Your usage plan shall enumerate the prospective buyers for the old machinery. 
  • Consider spending your cash credit loan on long thought marketing expenses which may help you to pick up the sales better.

 

Spreading the loan utilization

It may be very tempting to use all the funds at one go and spend on the entire to-do list. Your loan usage plan shall incorporate the phases in which you are planning to use your loans.

That is why; some lenders prefer giving term loans in multiple tranches. This inculcates discipline in spending and repaying the loan amount wisely. 

Even if the loan is given in one shot, the usage must be spread across. 

  • The first step is to park your loan funds in a different account than of your regular operative account. 
  • The funds must be transferred to your operative account as per the usage plan. 
  • You can plan in such a way that when you have repaid more than 55% of your first phase of a loan, the second instalment of the loan can be transferred. 
  • Be sure to calculate the interest as per the loan agreement. Some business loans are provided as limits where interest is charged only on usage. 
  • Term loans are charged on the full borrowed amount irrespective of the usage.

Repayment plan

A solid repayment plan as per the loan agreement must be incorporated into all your projected financials and budgets. Debt service coverage ratio (DSCR) is a measure to study whether your operating cash flows are sufficient to cover your debt obligations (EMI = Principal + Interest).

Debt Service Coverage Ratio = Net Operating Income/Debt Service

The ideal DSCR would be greater than 1.25. Monitoring your DSCR constantly would help you to understand whether you are earning sufficiently to meet the obligations.

 

Consult an Expert

While it is important to plan all your work, sometimes things can get better with professional help. Don’t hesitate to get experienced professional advice, if you are struggling to manage the loan funds on your own. It may save your time and help you concentrate well on your business.

 

Important points to consider

  • The cash flows are critical from the point of view of both the lender and the borrower. You should have a monthly, quarterly, half-yearly, and annual projection of cash flows. The lender payments (interest and principal) take the front seat when considering the external dues of a business. The actuals must be compared with the projections every month and deviations if any shall be provided in the projection of subsequent months. Good cash flow management represents good liquidity for a business. The lenders are largely interested to know how good is your liquidity ratio when it comes to business finance.
  • The projection of revenue goes hand in hand with the cash flow projection. The next important criterion for assessment is the debt-to-revenue ratio of your business. It is a must to ensure that the ratio is below 0.5. Ensure there are no missed EMIs and repayments as and when they are due. It is pertinent to note that the liabilities must be reducing and the revenue must be on an increasing trend.
  • Keeping your lender informed of any contingencies helps in maintaining a good relationship. The lender can also suggest a few measures to save your CIBIL™ score. Debt consolidation and bridge finances are a few options if you forecast any inability to repay your liabilities but they should be exercised with caution.

Conclusion:

The story does not end when you get a loan. The real challenge begins after it. The usage of the loan, internal revenue generation, and repayments are all important factors to be well-planned before approaching a business loan.

The intention of getting any kind of business loan is to run the business smoothly and efficiently. Ensure your revenue and sales plans are well in place. A viable and profitable business can take the significant burdens of a businessman concerning loans. Don’t forget to seek expert help when you need it.