Types of Business Loans in India
Businesses, regardless of their size, frequently need additional funds to manage daily operations and facilitate growth. The nature of the business—whether it is capital-intensive or its stage of development (inception, growth, or maturity)—largely determines the type and amount of funding required. Typically, businesses seek funds more actively during the initial stages and for expansion purposes. In this article, we will explore various types of business loans that financial institutions in India offer.
Broadly, there are eight types of business loans in India:
- Working Capital Loan
- Term Loan (Short & Long-term Loan)
- Letter of Credit
- Bill/Invoice Discounting
- Overdraft Facility
- Equipment Finance or Machinery Loan
- Loans under Government Schemes
- POS Loans or Merchant Cash Advance
1) Working Capital Loan
Working capital loans help businesses meet their daily operational expenses. These loans are crucial for maintaining cash flow, purchasing raw materials, managing inventory, paying salaries, and hiring staff. Typically, working capital loans are short-term, with amounts up to ₹40 lakhs and repayment tenures of up to 12 months or more. The interest rates for these loans tend to be higher compared to long-term loans, as they are designed for short-term financial needs. The lender sets a credit limit that the business can utilize for specific purposes.
2) Term Loan
Term loans are loans that need to be repaid in regular installments over a predetermined period. They can be categorized into short-term (up to 12 months), intermediate-term, and long-term loans (up to 5 years or more). Collateral-free business loans can go up to ₹2 crores, depending on the business requirements. The repayment schedule is set at the time of loan approval and is tailored to the business’s financial situation.
3) Letter of Credit
Letters of credit are primarily used in trading businesses, particularly for international trade. They serve as a payment guarantee from the bank, ensuring that transactions between unknown parties are secure. This type of credit is beneficial for businesses involved in import and export, providing assurance to suppliers about the payment.
4) Bill Discounting
Bill or Invoice Discounting allows businesses to receive funds in advance at a discounted rate from the lender. This is particularly useful when a business needs cash flow before the invoice due date. For instance, if a business has sold goods and is supposed to receive payment in 45 days, it can get an advance from the bank at a discounted rate, which improves liquidity. The bank charges interest on the advance, which is considered a discount for the seller.
5) Overdraft Facility
An overdraft facility allows account holders to withdraw more money than what is available in their account up to a certain limit. The interest is charged only on the amount utilized and is calculated daily. The credit limit depends on the account holder’s relationship with the bank, credit history, cash flows, and repayment history. Overdraft limits are usually revised annually and can be secured against collateral such as fixed deposits.
6) Equipment Finance or Machinery Loan
Equipment finance or machinery loans are designed for businesses to purchase new equipment or upgrade existing machinery. These loans are predominantly used by large enterprises and manufacturing businesses. Equipment finance offers tax benefits, and the terms, including interest rates and repayment tenure, vary among lenders.
7) Loans under Government Schemes
The Government of India provides various loan schemes to support MSMEs, women entrepreneurs, and other businesses in the trading, services, and manufacturing sectors. Loans under schemes like the Mudra Scheme (PMMY), PMEGP, CGTMSE, Standup India, Startup India, and PSB Loans in 59 minutes are offered through multiple financial institutions including private and public sector banks, NBFCs, RRBs, and MFIs. These schemes aim to promote financial inclusion and support the growth of small businesses.
8) Point-of-Sale (POS) Loans
POS loans or Merchant Cash Advances provide a lump sum advance to business owners, which is repaid through future credit or debit card transactions. This type of loan is ideal for businesses facing short-term cash flow issues. POS loans typically come with higher interest rates and are linked to the sales processed through POS machines installed at retail outlets, grocery stores, and shopping malls.
Understanding the various types of business loans available in India helps businesses choose the most suitable funding option for their needs. By comparing the offers from different financial institutions such as private and public sector banks, NBFCs, RRBs, SFBs, and MFIs, businesses can secure loans with competitive interest rates and flexible repayment terms.