Borrowing and lending have become a commonality in businesses in recent years, and bank loans are an essential part of this system. As with any other product, there are advantages and disadvantages of bank loans. Lets have a closer look:
Purchase without Liquidity
A major goal of a bank loan is to lend to people who do not have ready cash. A bank loan can help an individual or a business in buying something as simple as a car or a home for which he doesnt have a corpus, or it can help businesses to buy machinery or set up big units for which it doesnt have money. The scope of a bank loan is vast, and the borrower can borrow as per their capacity depending on their creditworthiness.
Driver of Growth
Bank loans are major drivers of growth, especially for public and private sector companies. Very few companies may have enough cash flow for financing huge expansion. However, in todays fast-track economy, expansion is the only way to have sustainable profitability. This is where bank loans come into the picture. Suppose, Company A wants to expand its production for which it needs to invest in machinery. If the cost of machinery is 5 times the companys yearly net income, Company A does not have to wait for 5 years to expand. It can borrow a term loan from the bank to fund its expansion plans and repay it over the next 5 years, thereby accelerating growth.
Provides Capital for Daily Operations
The banks have special loans that can help a company fund its day to day operational capital and cash cycle. The working capital bank loans and cash credit loans are major bank loans that are used for the purpose. This allows companies to be flexible about their debtor and creditor agreement. Suppose Company X has purchased goods worth USD , the payment of which has to be made in 10 days, whereas it sells these goods in USD , which it will receive in 30 days . In such a situation, Company X can borrow USD from the bank for 20 days and repay the USD to the bank after it receives payment of USD from the debtor. A major advantage of such loan is that the company has to pay interest only for the amount and the number of days for which it has borrowed.
Better Interest Rates
Before a century, the borrower would borrow money from unorganized money lenders. The money lenders would usually exploit the borrowers by asking exorbitant interest rates and abnormal collateral demands. With the rise of organized banking from the beginning of the 1900s, these troubles have vanished. Organized and systematic bank loans are provided to borrowers with minimal interest rates. Furthermore, even today bank loans are cheaper as compared to other loans from other financial institutions such as NBFCs.
Bank loans provide an element of flexibility to the borrower, which can be very beneficial in long-term. The borrower can choose the duration of the loan and amount of EMIs, whereas the amount of loan and interest rates are negotiable. For example, if an individual takes home loan from the bank, he can decide if he wants to repay the loan in 5, 10 or 20 years.
Accounting Tax Advantages
The interest on bank loans is deductible from taxable income, this is an advantage to the borrower in the form of tax savings. In addition, the borrower gets the advantage of budgeting and planning for monthly loan expenses. This is especially true for fixed-rate loans, although a simple model can be prepared for changes in floating-rate loans.