Complete Guide To Corporate Finance

AAA

Loans And Amortization - Introduction To Loans

Businesses often need to borrow money to finance business investment activities. Here are some of the types of loans a business might take out. Basic Loans
A commercial loan is a debt-based funding arrangement that a business can set up with a financial institution. The proceeds of commercial loans may be used to fund large capital expenditures and/or operations that a business may otherwise be unable to afford. This type of loan is usually short-term in nature and is almost always backed with some sort of collateral. Commercial loans usually charge flexible rates of interest that are tied to the bank prime rate or else to the London Interbank Offered Rate (LIBOR). Many borrowers must file regular financial statements, usually at least annually. Lenders also usually require proper maintenance of the loan collateral property.

Due to expensive upfront costs and regulation-related hurdles, smaller businesses do not typically have direct access to the debt and equity markets for financing purposes. Therefore, they must rely on financial institutions to meet their financing needs.

A term loan is a loan from a bank for a specific amount that has a specified repayment schedule and a floating interest rate. Term loans almost always mature between one and 10 years. Businesses use term loans for month-to-month operations or to purchase fixed assets such as production equipment.

An unsecured loan is issued and supported only by the borrower's creditworthiness, rather than by some sort of collateral. Generally, a borrower must have a high credit rating to receive an unsecured loan. Commercial paper is an example of an unsecured loan. A secured loan is backed by collateral; if it is not repaid, the lender can seize the collateral and sell it to recover the funds it lent.


An acquisition loan helps a company purchase a specific asset that is determined before the loan is granted. Acquisition loans are sought when a company wants to complete an acquisition for an asset but does not have enough liquid capital to do so. The company may be able to get more favorable terms on an acquisition loan because the assets being purchased have a tangible value, as opposed to capital being used to fund daily operations or release a new product line. The acquisition loan is typically only available to be used for a short window of time and only for specific purposes. Once repaid, funds available through an acquisition loan cannot be re-borrowed as with a revolving line of credit at a bank.

Revolving Credit
Revolving credit is another way businesses can borrow money, but the structure is a bit different than an ordinary loan.


A line of credit establishes a maximum loan balance that the bank will permit the borrower to maintain. The borrower can draw down on the line of credit at any time, as long as he or she does not exceed the maximum set in the agreement.

The advantage of a line of credit over a regular loan is that interest is usually charged only on the part of the line of credit that is used, and the borrower can draw on the line of credit at any time. Depending on the agreement with the financial institution, the line of credit may be classified as a demand loan, which means that any outstanding balance will have to be paid immediately at the financial institution's request.

Revolving credit may also be called an evergreen loan or a standing loan. Credit cards are also a type of revolving credit.

More Complex Loans
A self-liquidating loan is a type of short or intermediate-term credit that is repaid with money generated by the assets purchased. The repayment schedule and maturity of a self-liquidating loan are designed to coincide with the timing of the assets' income generation. These loans are intended to finance purchases that will quickly and reliably generate cash.

A business might use a self-liquidating loan to purchase extra inventory in anticipation of the holiday shopping season. The revenue generated from selling that inventory would be used to repay the loan.

Self-liquidating loans are not always a good credit choice. For example, they do not make sense for fixed assets, such as real estate, or depreciable assets, such as machinery.

Another type of loan related to a business's assets is an asset-conversion loan, a short-term loan that is typically repaid by converting an asset, usually inventory or receivables, into cash.

For example, let's say the TSJ Sports Conglomerate is short on cash it needs to pay its employees this month. One option they might explore is trying to get an asset-conversion loan to fill that short-term cash void.

Another type of loan that can help a business meet its day to day needs is a cash flow loan. Reasons for needing a cash flow loan could be seasonal-demand changes, business expansion or changes in the business cycle. Cash-flow loans can help in temporary situations, but if cash flow problems persist then companies need to improve their cash conversion cycle and get customers to pay faster.

A working capital loan can also be used to finance everyday operations of a company. It is not used to buy long-term assets or investments, but rather to clear up accounts payable, pay wages and salaries, and so on.

A company can also pledge its accounts receivable (AR) as collateral for a loan. A non-notification loan is a type of full-recourse loan that is securitized by accounts receivable. Customers making accounts-receivable payments are not notified that their account/payment is being used as collateral for a loan. They continue making payments to the company that rendered services or made the original loan, and the company then uses those payments to repay their lender for financing obtained. If customers do not pay accounts receivable, the company is still liable for repaying the loan it obtained using the AR as security.

A bridge loan, also known as "interim financing," "gap financing" or a "swing loan," is a short-term loan that is used until a company secures permanent financing or removes an existing obligation. This type of financing allows the user to meet current obligations by providing immediate cash flow. The loans are short term (up to one year) with relatively high interest rates and are backed by some form of collateral such as real estate or inventory.

As the term implies, these loans "bridge the gap" between times when financing is needed. They can be customized for many different situations. For example, let's say that a company is doing a round of equity financing that is expecting to close in six months. A bridge loan could be used to secure working capital until the round of funding goes through.

This is not an exhaustive list of the types of loans available to businesses, but it gives a general idea of the different options available. Businesses should shop around at different institutions to determine which lender offers the best terms for the loan.

Alternatives To Loans


Related Articles
  1. Credit & Loans

    Understanding Loans

    A loan is the act of giving money, property or other material goods to another party with the expectation of being repaid.
  2. Credit & Loans

    Personal Loans vs. Car Loans

    How to tell whether a personal loan or a car loan is better for you.
  3. Economics

    Understanding Term Loans

    A loan from a bank for a specific amount that has a specified repayment schedule and a floating interest rate.
  4. Options & Futures

    Different Needs, Different Loans

    Find out what options are available when it comes to borrowing money.
  5. Credit & Loans

    When Are Personal Loans a Good Idea?

    You never want to borrow money for frivolous reasons, but these five circumstances might warrant it.
  6. Credit & Loans

    How To Apply For a Personal Loan

    Learn about different avenues for applying for a personal loan, and learn valuable tips to help you get your personal loan application approved.
  7. Entrepreneurship

    Small Business Loan Vs Line of Credit: How They Differ

    Understand the differences between a small business loan and a line of credit, and learn some of the most appropriate uses for each form of financing.
  8. Credit & Loans

    Commercial Real Estate Loans

    Obtaining a commercial real estate loan is quite different from borrowing for residential real estate. Here's what to expect and how to get what you need.
  9. Credit & Loans

    All About Government Loans

    There are many reasons to seek a government loan rather than one from a private lender. Government loans typically have low interest rates and offer fixed or subsidized options, as well as deferred ...
  10. Credit & Loans

    Unsecured Personal Loans: 8 Sneaky Traps

    If you are seeking a personal loan, be aware of these pitfalls before you proceed.
RELATED TERMS
  1. Unsecured Loan

    A loan that is issued and supported only by the borrower's creditworthiness, ...
  2. Standing Loan

    A type of loan where payments are made of interest only. Repayment ...
  3. Call Loan

    A loan provided to a brokerage firm and used to finance margin ...
  4. Direct Consolidation Loan

    A loan that combines two or more federal education loans into ...
  5. Commercial and Industrial (C&I) ...

    Any type of loan made to a business or corporation and not to ...
  6. Character Loan

    A character loan is a type of unsecured loan that is made on ...
RELATED FAQS
  1. Are secured personal loans better than unsecured loans?

    Read about the differences between secured loans and unsecured loans and how they are used. Learn about forms of collateral ... Read Answer >>
  2. What are the typical requirements to qualify for closed end credit?

    Learn what closed-end credit is, and the various requirements that borrowers must meet in order to obtain a closed-end credit ... Read Answer >>
  3. What are the pros and cons of life insurance policy loans?

    Find out the pros and cons of borrowing against your life insurance policy to help you decide if this loan type is the right ... Read Answer >>
  4. What are the differences between delinquency and default?

    Find out more about loan delinquency, loan default, and the difference between a loan borrower defaulting and being delinquent ... Read Answer >>
  5. What are the typical repayment terms for a syndicated loan?

    Learn more about syndicated loans and how they are structured, specifically including the typical repayment terms for a syndicated ... Read Answer >>
  6. What are some examples of debts that I can consolidate?

    Read about different kinds of debts than can be combined into a consolidation loan, including unsecured debts, secured debts ... Read Answer >>

You May Also Like

Hot Definitions
  1. Return On Invested Capital - ROIC

    A calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments. ...
  2. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  3. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  4. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  5. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  6. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
Trading Center