One of the most crucial aspects of starting a Business on your own is capital management. Every business, be it small or large, involves a certain set of pre-requisites for it to take off. Good initial capital investment is one of them. Everybody desires for their business to be a success but only a few are capable to actually do it. A key principle behind that can be sourced as financial aids.
As there is a current boom of entrepreneurs across the world, where more individuals are shifting to start their own businesses, nearly all of them are on the hunt for getting a good capital resource before their start or which is popularly known as the start-up capital for a business.
This has not gone unnoticed by capital lending corporations such as banks and private lenders. As a result, there is an increase in the number of schemes that are ready to help the budding entrepreneurs in their quest for financial capital growth.
The entrepreneur of today have the following options to look for help in capital investment:
- Bootstrapping or getting a 0% interest credit card
- A business loan
- Venture capitalists
Out of these, the two most common options are Business Loan and Overdraft. This is because all the other methods of capital raising are unreliable and subjective to failure.
Now an important question that arises here is that between Business Loan and Overdraft which is a better option for an entrepreneur’s business? What are the pros or cons of choosing one over the other? Let us try to reach for the answers to these questions today but first, we will have to dive deeper into both the options one by one.
Overdraft: Its Meaning, Uses, Benefits, and Disadvantages.
What is an Overdraft?
Starting with Overdraft, it is fundamentally a facility where the individual can use capital on credit from the lending authority. The most common lending authority here is a bank. A bank overdraft involves the extension of an individual’s bank account through which the person can continue making cash withdrawals even if there are no funds available in his/her bank account.
The bank provides capital cover to the account holder in case there is a situation of insufficient in the individual’s account. An overdraft typically charges the account holder with a fee is known as the overdraft fee which is charged when the individual attempts to make a withdrawal and his/her account value reaches zero. A bank overdraft can be authorized or unauthorized.
When can you use a bank overdraft?
An individual or an entrepreneur can use bank overdraft service under the following conditions:
- When there is an emergency capital need and your bank account value has reached zero.
- When there is a risk of cheque bouncing
- If you are looking for a source of short-term borrowing
Benefits provided by bank overdraft:
The benefits of a bank overdraft include-
- An overdraft is helpful in a business when you have to pay the expenses in time, but you lack the receivables in your bank account. You can just pay for the expenses using overdraft to settle the outstanding cheque balances of your business and the finances can be restored once your receivables arrive.
- An overdraft helps the credit statements of your business because it prevents cheque bouncing and provides emergency cash withdrawals.
- Paying timely helps build a good reputation for any new business and an overdraft helps maintain on-time payments to your clients.
- Bank overdraft procedures are way less time-consuming than a business loan with about half the amount of paperwork
Cons of bank overdrafts:
While there are some benefits of an overdraft, this term does not have a good image in the minds of entrepreneurs. It is because-
- An overdraft is not a good source of start-up business capital because the bank often sets a limit to the funding which can be utilized by the individual as an overdraft. This can lead to improper budget planning for the business and hamper its expansion.
- The bank charges several fees and interest rates on an overdraft which normally tend to go higher than business loans and can go higher if you cross the fund limits. Hence, an overdraft can prove to be a costlier option in the long run.
The procedure of using an overdraft:
A bank overdraft is procured from the same bank in which the entrepreneur has an account in, as the capital is borrowed from the bank itself. The entrepreneur can make a request for an overdraft and its approval depends on his/her bank account value. An individual can either request a bank overdraft with account value zero or while having a certain sum in his/her bank account.
Business Loans: Meaning, Features, Benefits, and Disadvantages
What is a Business Loan?
One of the most popular choices among business capital enhancement options, a business Loan is the apple of every investor’s eye. A business loan is a contract of agreement between the bank (lending authority) and an entrepreneur who works to provide money for the expenses incurred on business. It is a method of borrowing money to utilize it for initial business investments and to set-up your business. The individual to whom the loan is sanctioned then has to repay it within a due limit and at a specific interest rate.
Features of a Business Loan:
- An entrepreneur can avail a collateral-free loan which is an unsecured business loan where there is no requirement of mortgaging your assets for capital
- A business loan comes with fixed interest rates which do not fluctuate over time
- Every business loan comes with a repayment tenure and an entrepreneur has to pay back the borrowed money within that specified period
- An entrepreneur can request a loan amounting up to Rs. 50 Lakhs if his/her business possess a good cash flow and credit score to support the claim
- An individual can also apply for a business loan online if they want to avoid the hassle of paperwork and document process.
- The procedure of loan application approval is done by the bank after a thorough investigation of the applicant’s business profile.
Benefits of a Business Loan
The business loan comes with a fair share of benefits for an entrepreneur which is the reason behind its huge popularity among entrepreneurs and business investors. Let us discuss the benefits in detail:
- A business loan provides an individual with the opportunity to borrow a large amount of money in a comparatively shorter time
- A business loan is a good choice of capital resourcing when an entrepreneur is looking for long-term business investment as the business loan is way cheaper than other options when it comes to borrowing over a longer period.
- Every business loan comes with a pre-determined interest rate which does not change and hence, the entrepreneur can plan future business ventures without any hesitation.
- There is a provision of tenure flexibility in business loans which helps remove the stress of repayment from an entrepreneur’s mind.
- A business loan can be filed both online and offline with minimal paperwork
- A business loan functions as a good working capital for a new business.
- A business loan is usually filed in the name of the entity. i.e. the business itself and not in the name of an individual so, the bank or NBFC cannot put the responsibility of repayment failure upon the entrepreneur.
Disadvantages of a Business Loan:
The cons of a business loan include:
- Some of the business loans can charge a very high-interest rate even if the loan is sanctioned for a short-term
- While secured business loans allow an entrepreneur to borrow a higher amount of money as loan compared to an unsecured loan, they often have a pre-requisite of collateral from the individual. This leads to the mortgaging of an entrepreneur’s assets.
- Stricter loan repayment conditions
- Some business loans can also charge the entrepreneur with penalties if he/she makes the repayment of the loan before the due date. This can cause inconvenience to the entrepreneur.
- Business loans have strict eligibility criteria that need to be fulfilled by the entrepreneur for loan approval.
Procedure to apply for a business loan:
The individual has to go through the following steps while availing a business loan:
- An individual should select the business loan scheme he/she wishes to apply for.
- Go over to the business loan provider’s website and select the scheme of your choosing
- Download the application form of the business loan and fill the required credentials
- Submit the completed application form by attaching the required personal/business documents. The documents required include:
- Applicant’s bank statement showing the transactions which have been done during the last 6 months
- Applicant’s income tax returns record of 3 years
- A document which supports the business-proof
- A document as evidence of the applicant’s business ownership
- Applicant’s identification proof
- If there is a co-applicant, then attach his/her KYC documents
- Applicant’s residential address proof- the electricity bill, phone bill, etc.
- The bank starts the process of application verification and furthers its approval or rejection.
- Once approved, the money is deposited in the respective account.
Business Loan vs Overdraft: A Comparison
Now that you have a general idea regarding overdrafts and business loans, let us have a quick look over their salient features and draw comparisons between them so that you can have a better image in mind.
· It is a form of agreement of money lending between the lending institution (bank, NBFCs) and the entrepreneur.
· Interest rates for business loans are calculated monthly.
· It is not compulsory to claim a business loan from the bank where you have an account.
· The process of a business loan application involves a thorough assessment of the applicant’s profile like verification of business operation, CIBL score, cash flow investigation, etc. Only after this verification, the application is subjected to approval.
· An entrepreneur can borrow as much as Rs. 30 lakhs to Rs.50 Lakhs by applying for a business loan.
· The interest rates are lower in comparison.
· Business loans provide flexibility in terms of loan tenures.
· Business loans like secured business loans require collateral from the applicant before lending capital.
· Business loans may charge a defeasance penalty.
· Beneficial for both long-term and short-term business investment.
· It is a form of credit extension where a bank enables the individual to withdraw funds even when their account value is zero.
· Interest rates for overdrafts are calculated on a day-to-day basis.
· An overdraft is done exclusively from the bank in which an individual has an account.
· The procedure for requesting an overdraft is much simpler. In case the candidate’s bank account reaches zero money, he/she can request an overdraft from the same bank which provides funding immediately.
· Overdrafts can provide a limited sum of funding amounting to a maximum limit of Rs 50,000/week.
· As the interest rates are charged daily, the cumulative sum can be higher.
· Overdrafts are not as flexible as the individual is required to repay the funding in a limited time.
· Overdraft does not require any collateral from the individual.
· While overdrafts don’t charge the individual with any penalties, there is, however, a provision of an ‘overdraft fee’.
· Much more appropriate for short-term business investment.
The decision of choosing between these two is, of course, subjective as both of them have their pros and cons. If you are looking for a source of capital enhancement for a long-term business venture, then go for a business loan as it offers a higher sum, lower interest rates, and longer repayment periods. But if you want to have a source of funding for a short-term or small business venture without going through intense application processes then you should go for overdrafts because they are a quicker way of acquiring capital.
Remember that capital enhancement is a crucial part of running a successful business so make sure you think your decision through and choose wisely!
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