How to Choose the Right Business Loan for Your Business

Check Your Credit Score

• Impact on Interest Rates: Higher credit scores, typically 700 or above, usually mean lower interest rates.
• Loan Amount: A good score helps you borrow more money.
• Loan Terms: Improve your score to get better loan conditions.

Review Your Debt-to-Equity Ratio

• Assess Financial Health: A ratio below 1 is generally healthy, showing a good balance between debt and equity.
• Avoid Over-Borrowing: Keep your ratio low to prevent financial strain.

Have a Good Understanding of Types of Business Loans in India

• Term Loans: Provide a lump sum for a specific period, used for expansion or buying equipment.
• Working Capital Loans: Help manage day-to-day expenses and cash flow needs.
• Overdraft Facility: Allows you to withdraw more than your account balance, useful for short-term needs.
• Trade Credit: Offered by suppliers to buy goods on credit and pay later.
• Equipment Loans: Specifically for purchasing machinery or equipment.
• Secured Loans: Require collateral (like property or equipment) to back the loan, often resulting in lower interest rates.
• Unsecured Loans: Do not require collateral but usually have higher interest rates and stricter eligibility criteria.

1. Understanding Your Purpose of Taking a Business Loan

Before choosing a loan, know why you need it. Are you expanding your business, buying equipment, or managing cash flow? This will help you decide the right loan amount. Borrowing too much means extra interest, while borrowing too little can limit your plans.
Suppose you need funds to buy a new machine to increase your production capacity. Here's how to determine the right amount:

• Machine Cost: You find a machine priced at ₹5,00,000.
• Installation Cost: Installation and setup will cost an additional ₹50,000.
• Operational Setup: You also need ₹25,000 for training and initial supplies.

Total Required Amount: ₹5,00,000 + ₹50,000 + ₹25,000 = ₹5,75,000

If you borrow more than this amount, say ₹7,00,000, you'll end up paying interest on the extra ₹1,25,000. On the other hand, if you borrow less, you might struggle to cover all your costs, potentially delaying or even jeopardising the installation and proper setup of the machine.

Tip: Always calculate the total cost thoroughly, including all associated expenses, to avoid borrowing too much or too little. This ensures that you're only paying interest on the amount you actually need.

2. Aligning with End Goals

Short-term vs. Long-term Needs

Once your objective is defined, align the loan tenor with your end goals. If the funds are for immediate working capital needs, a short-term loan is preferable. For larger investments like office space or machinery, a long-term loan would be more suitable.

Short-Term Loans?

• Purpose:Ideal for immediate needs, such as managing cash flow or purchasing seasonal inventory.
• Tenor: Typically ranges from 1 to 3 years.
• Repayment: Usually repaid in smaller, frequent instalments.
• Interest Rates: Generally higher due to the shorter repayment period.
• Example: A retail store might use a short-term loan to stock up on inventory for a festive season like Diwali.

Long-Term Loans

• Purpose: Suited for larger investments, such as buying equipment, expanding facilities, or significant renovations.
• Tenor: Typically ranges from 10 or more years.
• Repayment: Repaid in larger, less frequent instalments over a longer period.
• Interest Rates: Generally lower due to the extended repayment period.
• Example: A manufacturing business might take a long-term loan to invest in new machinery or build a new production facility.

Advice: Choosing the right loan term aligns with your business's goals and ensures that you have the financial stability needed to achieve your objectives without overstretching your resources.

3. Evaluating Loan Options: Understanding Types of Business Loans and Eligibility Criteria

Once you know how much you need and the loan term, start evaluating your options. Understand different loan types, such as secured and unsecured loans. Check your eligibility, interest rates, repayment terms, and collateral requirements before opting for secured or unsecured business loans. Compare loans from different banks to find the best deal. Also, review the lender's reputation.

Secured vs. Unsecured Business Loans

Take the Next Step with Confidence

Choosing the right loan for your business can be a game-changer. Whether you're gearing up for a big expansion or managing day-to-day operations, the right business loan can boost your business growth. Don't let financial constraints hold you back—explore the business loan options available to you and find the best fit for your needs.

4. Understanding Business Loan Interest Rates: Fixed, Floating, and Flat

When selecting a loan, you may find options with fixed, floating, or flat interest rates. Understanding these types can help you pick the one that best fits your financial strategy and impacts your repayment

Business Loan Interest Rate Types: Fixed, Floating, or Flat Interest Rates

Flat Rate Calculation Example:

• Loan Amount: ₹5,00,000
• Interest Rate: 8% per year (flat rate)
• Loan Tenure: 5 years

Total Interest: ₹5,00,000 * 8% * 5 = ₹2,00,000

Total Repayment: ₹5,00,000 + ₹2,00,000 = ₹7,00,000

EMI Calculation: ₹7,00,000 ÷ 60 months = ₹18,333

Impact: The flat rate may seem higher compared to other methods, as it calculates interest on the full loan amount for the entire period, rather than on the reducing balance.

Tip: Understand how each rate type affects your repayments and choose the one that fits your financial situation and risk tolerance best

5. Optimising Tax Benefits: Leveraging Interest Deductions on Your Business Loan

Learn how to maximise tax benefits from your business loan to reduce overall costs.

Interest on business loans can often be deducted from your taxable income, reducing your tax bill. Optimising the interest amount paid can therefore lower your tax liability. To know more about it, check out how you can leverage interest deductions.

Tip: Consult a tax expert to understand how to maximise these benefits, ensuring that you take full advantage of the available deductions.

6. Balancing Debt and Equity: Maintaining Financial Stability

Evaluate how much debt is manageable versus the need for equity financing.
The right balance between debt and equity is crucial for maximising returns while maintaining financial stability. An excessive amount of debt can be risky, so calculate your debt-to-equity ratio to avoid over-leveraging.
A debt-to-equity ratio of 1:1 is often considered healthy, meaning the business has an equal amount of debt and equity. This balance helps in leveraging growth while managing risks.

7. Avoiding the Debt Trap: Borrowing Responsibly

When taking out a loan, it's essential to borrow only what you can comfortably repay. Here's a simple guide to help you manage your debt responsibly:

Key Considerations

• Gross Monthly Income: The total revenue your business earns before any deductions.
• Monthly Debt Payments: Include all existing debts and new EMI payments.
• Expenses: Account for monthly costs like rent, utilities, salaries, and inventory.

General Guidelines

• Debt-to-Income Ratio: Aim for total debt payments, including the new EMI, to be no more than 30% to 40% of your gross monthly income. This helps ensure you have enough for other expenses and unexpected costs.
• Operating Cash Flow: Ensure your cash flow from business operations covers debt payments. A good ratio means you can handle your debts comfortably.

Example

If your business makes ₹1,00,000 a month:

• Monthly Expenses: ₹60,000
• Net Profit: ₹1,00,000 - ₹60,000 = ₹40,000
• EMI Capacity: Allocate up to 40% of your surplus income for EMI payments. Maximum EMI = 40% of ₹40,000 = ₹16,000

So, aim for an EMI of ₹16,000 or less to stay financially stable.

By following these guidelines, you can manage debt responsibly and keep your business financially stable.

8. Checking Terms and Conditions

Carefully review the loan's terms and conditions before finalising to avoid any surprises.

Be vigilant about the terms and conditions of the loan, especially regarding interest rates, fees, and flexibility in repayments. Hidden costs like processing fees, prepayment penalties, or other charges can significantly impact the overall cost of the loan.
Suppose, a loan with a ₹10,000 prepayment penalty can increase your costs if you repay early. Similarly, a low-interest loan might have a ₹5,000 processing fee, making it more expensive than it seems. Always consider these factors to see the true cost of the loan.

Final Take

Choosing the right loan requires careful planning and consideration of various factors. Seek expert guidance, thoroughly evaluate your options, and regularly review your loan terms and financial status. This approach will help you achieve growth and maintain financial stability.
For personalised advice and insights on the latest financial products, consult a financial advisor or loan specialist. To learn more about secured and unsecured business loans, contact Ambit Finvest.
Disclaimer: All calculations mentioned here are merely indicative in nature and meant for illustrative purposes only. Your actual costs may vary based on specific factors and circumstances.