Loans
A loan is the purchase of the money with the promise to return the amount according to
a pre-arranged schedule and at a mention rate of interest. Loan contracts between the lender and borrower.
Loans are the most common type of liability financing used by
small businesses. Loans classified as long-term (with a maturity longer than one year), short-term
(with a maturity shorter than two years), or a credit line (for more immediate borrowing needs). They can
be authorize by guarantor, accounts receivable, inventory, savings, life insurance, stocks and bonds, or the item
purchased with the loan. The interest rate charged on the borrowed funds reflects the level of risk that the lender undertakes by providing the money.
For example, a lender might charge a startup company a higher interest rate than it would a company that had shown
a profit for several years.
Loans are described according to their maturity into short-term debt, long-term debt, and intermediate-term debt.
Revolving credit and perpetual debt have no fixed
date for retirement. Banks provide revolving credit through extension of a line of credit. Brokerage firms give
margin credit for qualified customers. In these cases, the borrower constantly turns over
the line of credit by paying it down. A perpetual loan requires only regular
interest payments.
The payment is generally consist of two parts: a portion of the outstanding principal and the interest costs With
the passage of time, the principal amount of the loan is amortized, or repaid little by little until it is
completely retired. As the principal balance diminishes, the interest on the remaining balance also become less.
Interest is the cost of borrowing money. The interest rate charged by lending institutions must be sufficient
to cover operating costs, administrative costs, and an acceptable rate of return. Interest rates may be fixed
for the term of the loan, or adjusted to reflect changing market conditions. A credit contract may adjust rates
daily, annually, or at intervals of 3, 5, and 10 years. Floating rates are tied to some market index and are
adjusted regularly.
Consumers and small businesses obtain loans with varying maturity periods to fund purchases of real estate,
transportation, equipment, supplies, and a vast array of other needs. According to W. Keith Schilit in The
Entrepreneur's Guide to Preparing a Winning Business Plan and Raising Venture Capital, they receive these
loans from a number of sources, including friends and relatives, banks, credit unions, finance companies,
insurance companies, leasing companies, and trade credit. The state and federal governments sponsor a number
of loan programs to support small businesses. Following are examples of some common types of loans.
A special commitment loan is a single-purpose loan with a maturity of less than one year. Its purpose is
to cover cash shortages resulting from a one-time increase in current assets, such as a special inventory
purchase, an unexpected increase in accounts receivable, or a need for interim financing. Trade credit is
another type of short-term loan. It is extended by a vendor who allows the purchaser up to three months to
settle a bill.
Mortgage loans are used to purchase real estate and are secured by the asset itself. Mortgages generally
run between ten and forty years. A bond is a contract held in trust with the obligation of repayment.
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