A commercial loan is a loan taken out by a company from a lending institution, often a bank, to finance the company’s operations. Companies often employ this financing to make large-scale capital purchases and/or meet operating expenses that would otherwise be out of reach. Due to high initial expenses and regulatory restrictions, direct access to bond and stock markets for funding is sometimes unavailable to small enterprises. This implies that smaller enterprises, like individual customers, must depend on alternative financing instruments, including lines of credit, unsecured loans, and term loans.
Functioning of Commercial Loans
Commercial loans are made to many businesses to help with their immediate cash flow requirements, such as paying for overhead or investing in machinery and tools. For some businesses, getting a loan means they can keep the lights on, pay their staff on time, or stock up on materials essential in production and manufacturing.
Suppose a company takes out one of these loans. In that case, the bank will likely demand collateral in the shape of property, plant, or equipment it may seize in the case of failure or bankruptcy. A loan may be secured, in part, by the expected cash flow from accounts receivable in the future. Some business loans take the form of mortgages on commercial properties.
Special Thoughts
When deciding whether or not to provide a commercial loan, the applicant’s creditworthiness is a primary factor, as it is with almost all loan types. Typically, a loan application would need the firm to provide evidence of a positive and stable cash flow, such as financial statements. In this way, the lending institution is certain that the loan can and will be returned as agreed.
If a business applies for and receives a commercial loan, the interest rate it will be charged will be set according to the prime lending rate when the loan is made. During the loan term, banks often ask the borrowing firm to provide monthly financial statements and to insure any significant assets bought with loan proceeds.
Classifications of Business Loans
While most people think of commercial loans as temporary business funding, certain banks and lenders provide loans that may be renewed forever. This gives the company the means to continue operating and repay the initial loan within the agreed-upon time frame.
This allows the loan to be “renewed” for an extended term if desired. Businesses often seek to revolve commercial loans when they need to increase their working capital to meet the demands of peak seasons for some of their biggest customers without interrupting their ability to serve their other, more consistent clientele.
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