How do Business Loans Work?

Whether you have a new business or an established company accessing funding is essential for a variety of reasons from expanding the business to managing cash flow through seasonal trade fluctuations.

This ABC finance deep dive explains how business loans work, what the key terms to be aware of are and how to apply for a business loan.

There are many different types of loans available and some of these are specialist financial products specific to particular types of business activities; and so it is key to work with an experienced loans broker who understands the market and the full range of products available so that you can get the best rates.

What are business loans?

Business loans are a type of financial product that is specifically designed to provide capital to businesses. One of the first choices to make when looking for a loan is whether you want your loan to be secured or unsecured, and this is covered in more detail in our ‘types of loan’ section.

Secured loans will be linked to an asset whether that be a property, business assets such as equipment, high-value stock or company vehicles. Lenders see secured loans as lower risk as they have a stake in the assets as security.

Loans can also be unsecured and in these cases lenders will assess suitability on creditworthiness of the business or evidence of future income in terms of contracts or orders placed.

Your broker will work with you to understand your needs and advise on which option is most suitable. For example, if your business is seasonal with good credit history, a full order book, a number of contracts and an immediate need for cash-flow then a short term unsecured loan may be the most suitable option. If, however, you wish to make a significant long-term investment in a business that would require substantial funding then longer term financing is likely to be more appropriate.

Longer term financing

Longer term financing is designed for growing business to enable them to invest and make significant commitments. Typically a long-term loan will range from three years to ten years and in some cases up to 25 years. Long term loans are secured against assets such as property or equipment.

This type of loan is often used for substantial purchases and the loan amount is generally much larger than short term loans that are often used to maintain cash flow.

Short term financing

Short term financing is designed for businesses with an immediate need for funds and can be secured or unsecure. Typically a short-term loan will range from three to 18 months, although some lenders may offer repayment periods up to two years in duration.

There are some general advantages to note when seeking a short-term loan. They can be quick to arrange, often within 24 hours, and require minimal paperwork. A short-term loan may be made available even in the event of the applicant having poor credit history.

In some situations there are draw-backs to taking a short-term loan to raise funds. Higher interest rates can be levied if a loan is unsecured and early repayment fees may be charged if the loan is repaid early.

How do they work?

Business loans are very similar to a personal loan in that a lump sum of money, or credit, is advanced to a business and this must be repaid over time with interest, and in some cases a fee or deposit will be required. With a business loan, however, the liability for the loan rests with the business and so if the business is sold these debts remain with the business. If you are seeking a loan to buy a business you must also complete due diligence to understand if the business you are buying already has any debts or legal liabilities.

A first step before applying for a loan is to prepare a business plan showing what the loan will be used for. Your business plan should be as detailed as you are able to make it and clearly show how a loan will help your business achieve its targets. For example, investing in equipment may help you to fulfil more orders or take on new contracts.

There are a huge range of financial products and loan options and it is very important for lenders to understand what the loan will be used for as this can help your application.

Once you have decided how much you need and what the funding will be used for then you will need to compare financial products and lenders. It is advisable to use a specialist broker to ensure you understand the types of financial products available and what will be most suitable for your needs.

There are several steps to take before you apply for a loan. Firstly, your business will need to be registered in the United Kingdom and you will need to provide paperwork such as bank statements and tax returns to demonstrate income. A range of documents are needed to apply for a long term business loan, although requirements may differ between lenders in most instances you will need to provide the following:

  • Proof of company incorporation
  • Bank statements
  • VAT returns
  • Inventories
  • Business plans

What are business loans used for?

Business loans are flexible and can be used for a wide range of purposes, including:

  • Maintaining cash flow and working capital to ensure regular running costs such as utility bills, rent and payroll are covered. Most businesses will have variable needs for cash flow throughout the year and seasonal fluctuations. For example, a farm selling Christmas trees will need temporary staff in December and need to outlay money for wages and recoup this over the busy sales period.
  • Business growth, including buying new premises, hiring more staff, purchasing stock, equipment or undertaking marketing campaigns.
  • Debt management and tax liabilities, a business loan can be helpful to manage large bills such as corporation tax.

Corporation tax is based on the profit your company makes and in the UK the rate is 25% on all limited companies. There are over five million registered companies in the UK and those that are trading will need to pay corporation tax to His Majesty’s Revenue and Customs (HMRC). HMRC is the UK’s tax, payments and customs authority.

Whilst it is advisable to put aside money to pay corporation tax, this isn’t always possible when a business is growing and cash flow is needed; however, a late tax payment can incur fines and penalties.

Taking a loan specifically to pay corporation tax can help manage cash flow by spreading payments over a longer term whilst meeting tax commitments and avoiding late payment fees.

There are many specialist lenders offering tax loans that can pay your bill upfront and then spread the payments over time from three to 18 months, giving you the flexibility to be able to manage your cash flow.

Types of business loan

Secured loans for businesses

Secured loans for businesses are based on assets or ‘collateral’ so the lender will have confidence that monies can be recouped if the business defaults on payments. Often assets such as property, or merchandise are used to secure loans.

Interest rates on secured loans are often lower as there is a guarantee that the lender will get their money back; however, with long term secured loans interest rates can be higher as a lender is tying up funds for a long period.

Unsecured loans for businesses

Unsecured loans for businesses are a type of credit that isn’t based on assets such as property or stock. Lenders will assess the creditworthiness of a business and the likelihood that they will be able to pay back the loan. Unsecured loans are often shorter term arrangements.

This type of loan is considered to be higher risk as the lender does not have certainty the payments could be met, or that they will receive their money if the business defaults on the arrangement. Unsecured loans ordinarily have higher interest rates than secured loans.

Invoice finance and factoring

This allows you to use your outstanding invoices to secure financing. Factoring is where a lender will pay you directly and take ownership of the invoices, they will collect the payment and keep the payment. With invoice factoring the lender will take a fee for providing the service or a percentage of the invoice amounts.
Invoice discounting is part of the invoice finance range of options and this is where the buyer pays promptly for a discount on goods or services.
Invoice financing can help a business maintain cash flow if payments are outstanding for a long time and money is required urgently.

Business line of credit

Another option is a business line of credit, a flexible loan allowing businesses to access funds either as a lump sum or in instalments until the total loan amount is used up. Access to a line of credit may require the borrower to use assets as security on the loan.

Merchant Cash Advance (MCA)

A Merchant Cash Advance (MCA) is a form of credit, however it is only available to businesses that accept debit and credit card payments. Finance is provided in exchange for a percentage of credit and debit card sales revenue. It should be noted that there may also be additional fees to pay when entering into an MCA agreement.

This form of loan can be helpful for small businesses that do not have significant assets that could be used as collateral for a loan.

Business overdraft

A business overdraft is short-term cash injection to a business bank account. If approved by your lender, the required overdraft limit can be increased or decreased to suit your business needs. Business overdrafts differ from a loan in that interest is only charged on the amount by which the business is overdrawn. The overdraft can be repaid as your income allows, but it is worth remembering that your bank may demand repayment at any time. The lender may also charge a fee for the overdraft.

Business credit cards

A business credit card plays a pivotal role in managing a company’s finances, and is specifically for corporate use. They are available to businesses of varying sizes, and can be used to effectively differentiate personal expenditures from business-related costs.
Although business credit cards operate similarly to regular credit cards, there are some notable differences. The most notable difference is that the borrowing limit on a business credit card is generally higher than a standard credit card, as it is based on personal income combined with the business’s revenue.

One further benefit of using a business credit card is that if repayments are made on time this can have a positive impact on the business’s credit rating.

Business van finance

Business van financing is designed for businesses that require vehicles for their operations; it allows businesses to purchase, or lease vehicles, without considerable upfront costs.

Asset and inventory financing, also known as warehouse financing

Asset and inventory financing, also known as warehouse financing provides short term funding based on the value of a company’s inventory or assets, helping businesses manage cash flow tied up in stock. This option is often used by smaller privately owned businesses that don’t have access to other lines of credit.

How much do business loans allow you to borrow?

ABC works with a wide range of lenders and frequently arranges business loans from £5000 to £750,000 with rates from 5.5% with terms from 3-72 months. In many cases ABC can arrange funding within 24 hours.

If you are seeking funding beyond £750,000 – for example if you are buying a business then contact ABC Finance for a callback and professional unbiased advice. We work with lenders that provide large business loans from £6000 to £10 million.

Typically a business can borrow up to 25% of its annual turnover, however, a number of factors are taken into consideration when deciding how much a business can borrow.

Secured loans may result in a larger sum being offered than an unsecured loan. The lender is also likely to assess the business’s cash flow, its annual turnover and whether the business is profitable. If a business is relatively new then a range of financial products may be combined to achieve the funding required.

Why should I use a broker to take out a business loan in the UK?

A business loans broker is a specialist who helps borrowers find finance that matches their requirements. Brokers help businesses apply for loans and negotiate with lenders to find their clients the best possible deal. Whilst business can apply to lenders directly this can be a time consuming process, and with a large range of financial products available it is preferable to seek expert advice.

Many lenders have strict criteria and a broker will be able to recommend financing options that are most suited to your business and your requirements. A broker will also manage the application processes making it streamlined and stress-free.

Using a broker can save you money as an expert business broker will be able to negotiate on your behalf getting you the best possible deal. They have access to a wide range of lenders and will be able to compare options and rates.

Brokers will charge a fee or commission, however, an expert broker is likely to be able to negotiate a good deal that can offset their fee.

It is important, however, to ensure you work with a broker that has specialist business experience and is regulated by the Financial Conduct Authority. Consumers in the UK are protected by the Financial Conduct Authority, an independent body that promotes best practice in financial markets, sets standards and investigates issues of bad conduct.

ABC Finance business has been supporting businesses since 2000 and is regulated by the Financial Conduct Authority. Our experts work with a wide panel of lenders and take time to understand your business needs to get you the best deal; our aim is to save you money.

We’ve helped over 30,000 businesses find a loan – our Trustpilot scores and reviews demonstrate how happy our customers are with our service.

Can I get tax relief on business loans?

Tax relief can be a complex area and the rules and so make sure to consult a financial specialist if you are looking to reduce your tax liabilities.

It is possible to obtain tax relief on some loans; however this depends very much on the financial product you choose. For tax purposes, a loan will be split into two different parts, and only one will be eligible for tax relief, here we explain how tax is applied:

Principal payments

Principal payments when you take a loan one part of your repayment will repay the loan itself, known as a principal payment. You will also pay interest on the loan.

UK businesses cannot claim tax relief on a principal payment and this is because it is viewed as a ‘capital expenditure by HMRC.’ A capital expenditure is seen as something that improves the long term outlook of a business such as gaining assets, expanding a business, or moving to larger premises would be put in this category.

Interest payments

Interest payments are tax deductible and so tax relief can be applied to this portion of a loan. It is important to demonstrate clearly what your interest costs are and this can be shown by the lender in a yearly statement.

Capital allowances

Capital allowances are a type of tax relief for businesses and in some circumstances HMRC may allow you to write off a portion of the cost of an asset against taxable profits each year. Over time your asset will depreciate in value and a capital allowance allows this to be recognised through the tax system on a yearly basis.

The amount you can claim against capital allowance will vary depending on the type of asset you are applying it to.

There are some particularly complex areas of tax relief relating to electric vehicles purchased for business use. In this instance, speak to ABC Finance to match you with a lender that specialises in providing vehicle finance so that you are aware of all the options, including potential tax incentives, before taking finance.

Can a business borrow money if the owner has bad credit?

Yes, in most cases we can work with our lenders to find a solution to your finance requirements. Whilst good credit is always helpful in terms of approvals, a poor credit rating is not necessarily a barrier to getting an arrangement. It is important to work with a specialist lender who understands this type of finance and who will look at your current situation to assess what will work for your business.

Lenders take into account a range of circumstances and this can include a business being relatively new with little credit history, or a business that has suffered setbacks due to external factors beyond its control. Whilst your business may not have built up a strong credit score it may be that it has very strong cashflow and lenders will factor this into their decision.

Having a firm business plan and being able to show what a loan will be used for, in particular how it will improve your business is one of the most useful ways that you can support your loan application.

It should be noted that the interest rates on loans may be higher for businesses with bad credit although there are a number of ways that lenders can work with businesses to reduce risks of default. Types of financial products can be combined and in the case of large business loans some lenders will allow personal loans from a senior management team to be combined with loans based on business assets.

Comparing lenders by using a specialist broker is recommended to ensure you get the best financial package for your business.

Contact ABC regulated by the Financial Conduct Authority for a callback and discussion about your needs. With twenty years of experience in trade finance and a wide panel of lenders, we focus on getting you the right solution for your business.

https://abcfinance.co.uk/

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