Small business financing
Small businesses are playing an important role in gross domestic product figures and employment generation across the globe. Governments have adopted pro-active measures for assisting small businesses in number of ways. Small business financing is one of them. This aspect takes care of the financial needs of small businesses. Government agencies, private as well as nationalized banks, specialized small business financial institutions are some of sources offering small business finance.
In United States, SBA or Small Business Administration has been created for taking care of financial requirement of small businesses. In past one decade, barring last 18 months, small businesses have developed at a great pace. Due to recession, their development and subsistence have been hit hardly but governments are making efforts to put them on track once again. Women have been given preference in small business financing.
Similarly, weaker sections of society are also assisted in numbers of ways for starting small businesses. They are offered loans at lower interest rates so that interest burden is minimized. Similarly, professionals like physicians, engineers etc are offered with attractive rate loans for starting up their own units. Governments are fully aware that unemployment cannot be tackled without developing small businesses. Without finance, there cannot be any small business development.
There are many reasons for which small businesses need finance. Let us try to understand these first.
Why Finance is Needed By Small Businesses
Start up is the first reason for which finance would be required by any small business, if entrepreneur is not able to provide adequate capital. In practice, it has been seen that people like to start up small business through finance rather than putting whole capital. This allows for greater financial leverage and meeting emergency financial requirements. Start up small business financing is offered by way of term loans for acquiring land or commercial space or machinery etc.
Sometimes, grants are also offered but these are not very common. Second reason for which finance is needed is to maintain adequate stocks. These include finished items, raw materials, and semi processed goods. Actual type of stock differs from one type of small business to another. For expansion purposes also, small business financing is available. In such cases, collateral or security for the loan amount is obtained.
Types of Small Business Financing
There are many types of small business financing available. Actual facility may differ from one country to another. Cash Credit Limit is the most common type of small business finance. In this type of facility, stocks carried by the small business are hypothecated in the favor of financial institution which is generally bank. Hypothecation means that stocks would be in control of small business and it can sell them and acquire new stock for business purpose but in case of non-repayment of the loan facility, lender can take charge of stocks and can sell the same for the realization of outstanding balance. In this type of finance, small businesses are provided with a withdrawal limit. Amount can be withdrawn and deposited up to this limit without any restriction to number of times.
Amount is generally withdrawn by the small business through checks. Cash credit cards are also in vogue these days which can be used at ATM's. This facility is liked by small businesses in good numbers as they are able to meet their liquidity requirements. Whenever there is surplus cash available, it can be deposited for reuse of limit. One striking feature of this type of credit facility is that interest is applied on the used amount only. Apart from stock hypothecation, no other collateral is generally asked for. In a nutshell, it can be said that cash credit facility is taken for fulfilling gap between current assets and current liabilities.
Second type of loan facility available to small businesses is term loan. As the term suggests itself, this facility is provided for a decided term. Maximum repayment term can range from 15-25 years depending upon the lender and the purpose. Term loans are taken by the small businesses for the acquisition of fixed assets. Fixed assets are those assets that are carried up to numbers of years and which depreciate with time. For example, land and machinery are two common fixed assets for which small business financing is available. Unlike cash credit facility, loan amount is given one time only and there is no reuse facility available.
Once asset has been purchased out of loan amount, it cannot be withdrawn again for any purpose. Repayment is done through pre-determined loan installments. Installment of loan repays principal as well as interest portion of loan. In practice, interest rate attached with term loans are lower than the rates attached to cash credit facilities. Moreover, term loans are offered against the collateral like land etc.
Apart from above two types of small business finance, there are some other facilities also that are taken by small businesses. For example, bank guarantee is one such facility. This facility is used for acquiring orders from customers. Invoice factoring or bill discounting is also a way in which small business finance is taken. Suppliers get their bills raised on customers discounted or factored and get the amount immediately. Loan amount is squared on date of bill payment. Current account overdrafts are also permitted by banks to their customers. But these should be paid in a limited period of time.
As said above, small business grants are also available. However, there are many applicants and only few of them are selected. One benefit of grant is that amount obtained is not paid back. Grants are offered as a part of government commitment towards development of small businesses in the region. These are taken care of by specialized government departments.