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How business loans can help improve your profitability

Updated: Dec 28, 2021

Business requires finance for various reasons such as to maintain business operations, invest in equipment, start a new branch, or any number of other motivations. Finance helps to fuel the growth of the organization.


To finance the operations of business banks and financial institution extends credit on the viability of the business and ability to repay. Loans are generally provided to you on basis of credit score. If you have never borrowed, you will not have a credit history with the bank. As you borrow, your credit profile gets built up and so does the relationship with a bank. The trick is to borrow money when you may not need it and an amount that would not hurt you. Pay it back and build your credit profile as you go along. It would be very helpful if in the process you can get yourself a line of credit that you can utilize whenever you need it.


To fund working capital limits, one can draw cash credit in which bank or a lending institute parks a certain sum of money that you can dip into and you pay interest only on the amount you have withdrawn from it and only when you actually avail the offer.


These smaller short-term loans are also a great way to build a profile for a bigger loan if you need it in the future. If you suddenly turn up at a bank with a request for a large loan, which may be to expand your business or fulfil a sudden large order, the chances are you will find it very difficult to get one.


Benefits of business loan


Additional Liquidity

Liquidity is a parameter to measure how far your company’s current assets can fulfil its obligations. Simply put, it measures your business’s ability to make cash available where and when it is required. A business loan can provide your business with this liquidity and measures how efficiently your organization uses its assets.


Manage Cash flows

Cash is every business’s lifeline. With a small business loan, you can stabilize cash levels and maintain them. This flow of cash can serve varied purposes, including payment to creditors, disbursement of payroll, inventory procurement, dividends payment, and everyday expenses.

Your business operations may suffer if there is a delay in fulfilment of any of these liabilities. For instance, if you don’t have cash to refill your inventory, you won’t be able to continue business operations. With a working capital business loan, you can purchase inventory in bulk and ensure adequate storage of goods. Besides that, you can also rely on a business loan to make payments to your suppliers.

Business loan can help you avoid missing your payments. If you are short of cash to pay salaries to your employees on time, experienced and qualified team members may start leaving your organization, which will ultimately harm your business. You may use your working capital loan to avert such adverse situations.


Improve Profitability

Business loans can help improve the Return on equity for the business owners. Return on equity is Net profit earned during the year divided by the net-worth of the business which is fixed assets less all outside liabilities.


Let us understand by an example.

Assuming a business, having turnover of Rs.1 crore, EBITDA margin of 15% and capital of Rs.50 lakhs, is looking to expand. Business promoter has two options either to infuse own capital or borrow the same amount. It expects with additional 25% of capital business shall grow correspondingly by 25%.

(Rs. In thousands)

Business

Scenario I

(Infuse own funds)

Scenario II

(Borrow funds)

Working Results

Total Operating Income

10,000

12,500

12,500

Less: Cost of Goods Sold

8,500

10,625

10,625

EBITDA (A)

1,500

1,875

1,875

Less: Depreciation

500

625

625

EBIT

1,000

1,250

1,250

Less: Interest

0

0

125

PBT

1,000

1,250

1,125

Less: Tax at 30%

300

375

338

PAT (B)

700

875

788

Financial Position

Net-worth

5,000

6,250

5,000

Debt

0

0

1,250

Total Capital Employed (C)

5,000

6,250

6,250

Ratios

ROCE (%) (A/C*100)

30.00

30.00

30.00

ROE (%) (B/C*100)

14.00

14.00

15.75



Promoter’s fund may increase profits on an absolute basis. However, promoters are earning additional Rs.Eighty-eight thousand on the same capital thus enhancing their return on equity from 14% to 15.75%.


However, one should take a bite which he can chew. Hence, a business should take a loan up to which it can comfortably serve the repayments. As per general banking consensus, debt-equity should not go beyond 2:1.


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