Finance is necessary for a business setup. Along with having a ground-breaking business idea, you need money to turn your plan into reality. Adequate and timely investment is key to running a healthy, functional business. But what if your business needs an injection of money,and you are short on cash? In such times of need, lending money from banks or other loan lending organizations is the right step.
Lending can be for various reasons; you could lend to buy a house, to purchase machinery or equipment for your business, buy a car, etc. Whatever the reason may be, you will have to meet a set of requirements laid down by the organization lending the money. For instance, if you are borrowing for your business, the lender may have specific business loan requirements that they would expect you to follow.
However, before entering into a loan agreement, you should be very sure of the clauses that the loan agreement entails. The deal will bind you in the long-run until you pay the loan off; hence, the contract must be thoroughly understood and analyzed before the signing off. We have highlighted a few pointers that you can use while judging whether a loan agreement is appropriate and affordable for your business or not.
The Monthly Repayment Amount:
The borrowed cash is not your money and hence, needs to be repaid. All bank loans granted would have an agreed-upon repayment schedule. You will have to pay specific amounts over several years to ultimately pay-off the borrowed money. To make repayment easy, you must consider your loan-to-income ratio. It is a basic rule of thumb that you should always work within your means. Hence, borrowing money that you would not be able to pay later would put your business in a rut.
With all the commercialization of the banking sector, it may be easy for you to find an organization to lend you money. However, what you need to focus on is your ability to afford a particular loan. Keeping your monthly cashflow in mind, devise a figure which you can utilize in repaying off the loan. It would help your business keeping an account of the cash inflows and outflows and not suffer from liquidity problems later on when paying off the debt.
The Length of The Contract:
The repayment schedule involves the period the loan would be repaid over. The shorter the repayment period, the higher the yearly pay-off amount. Hence, an appropriate repayment schedule should be devised, keeping in mind your business cashflow situation. If your business often suffers a tight cashflow, then a loan plan which spreads the repayment over several years would be more affordable. However, this would bring with it the added interest charge every year.
On the other hand, if you pick a shorter period, delayed payments due to cashflow problems may mean penalties and fines. Therefore, it is imperative to choosethe rightloan agreement that offers a repayment period that suits your financial situation and needs.
The Finance Cost Charged:
In the business world, services are never provided without a charge.Each business works by earning a profit on the products or services offered.Therefore, the borrowed money also comes with a cost that is in terms of the interest rate. To ensure that the loan agreement is affordable for your business, make sure that the interest cost charged does not exceed your interest expense capacities.
The lenders may charge a fixed or a floating fee on the borrowed money. Under a fixed interest rate, a constant amount is charged over the years on the owed amount. Whereas under a flexible interest charge, the cost keeps fluctuating based on several factors. You will have to conduct a thorough analysis to judge which interest rate would be the most beneficial for you. Deciding the volatility of the flexible interest rate will help you derive the probable interest expense in the future. It will aid in picking the most cost-effective interest rate when borrowing money.
Penalties Charged on Prepayment and Delayed Payments:
While the lender would devise a loan agreement, it is standard practice for them to lay down in the contract penalties for few misconducts. One of these misdemeanorsisimproper or delayed payments. The loan agreement would have designated deadlines for the repayment of the principal amount and the payment of the interest rate charge. The lender would expect you to pay off the expenses before these deadlines.
In case they are not timely paid, a penalty or fine may be charged. The contract would have all the related clauses. Therefore, you will have to judge your cashflows and conclude whether you can make timely outflows or not. Delayed payments will increase your lending expense and may become a burden for your business in the long-run.
Additionally, some lenders may also charge you for prepayments. Even though it is considered good practice to be on time with your payments, paying the loan before the due date may also place a penalty on your business. It is because the lender will not be able to receive the interest amount for the years you pay off the loan. For example, if the loan is for five years and you decide to repay the entire amount at the end of the third year, the lender would not be able to receive any interest charge for the last two years.
Before getting into a loan agreement, you should thoroughly review the penalty clauses to make sure the loan does not turn into a financial burden later on in the future.
Consequences in Case of Default:
Approximately all loan agreements would have a default clause attached to them. It would specify the penalties and damages the lender would claim in case the borrower is unable to repay the loan amount. Defaulting a loan payment may bring with it severe consequences such as hefty fines, legal actions, forceful resale of assets, etc. It can also be seriously damaging for the image of the business in the long-run.
The lender may sue your business for default and may claim large sums of money in terms of damages. Additionally, your business will have to face legal costs as well. To judge whether a loan agreement is affordable in the long-term, you need to keep in mind all the resulting consequences, including the penalties in the contract for default.
Financing is a crucial aspect of any business. You need appropriate and timely investments to make sure your business thrives and flourishes in the right direction. Lack of funds and money may sometimes restrict entrepreneurs to grow their business; however, borrowing money is a great way to inject your company with the needed capital. Choose a loan agreement that best suits your requirements and business scenarios and help your business achieve its full potential.