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Q&A - What is a bank loan?

Friday, May 01, 2009
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A bank loan is the most common form of loan capital for a business.

A bank loan provides medium or long-term finance.  The bank sets the fixed period over which the loan is provided (e.g. 3, 5 or 10 years), the rate of interest and the timing and amount of repayments. 

The bank will usually require that the business provides some security (“collateral) for the loan, although in the case of a start-up this security often comes in the form of personal guarantees provided by the entrepreneur.

Bank loans are good for financing investment in fixed assets (such as plant & machinery, land and buildings).  They are generally charged at a lower rate of interest that a bank overdraft.  The interest rate can be either fixed (e.g. 8% per year on the amount outstanding) or variable (where the interest rate varies depending on the Bank of England base rate).

However, a bank loan provides less flexibility than a bank overdraft. The business commits to meeting the bank loan repayments and interest – which it needs to do whether or not the cash flow position is good. A failure to meet the terms of the bank loan may lead to the bank putting the business into insolvency.

Bank loans tend not to be offered to start-ups or businesses with a track record of poor profitability and cash flow.  Such businesses are perceived as being high-risk by banks that, as a result of the credit crunch, are more cautious about the kind of lending they offer.



 

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