Why Do Businesses Apply For Loans

Why Do Businesses Apply For Loans

There are various reasons for small businesses to apply for a business loan from commercial banks. Loans are taken from other sources too. There are credit unions that offer business loans for small businesses.  Loans are usually taken keeping inventory or accounts receivables as the collateral. It is quite expensive for the organization to borrow money and is also associated with risk. However, debt is an indispensable part of business operations.

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Below mentioned are the various reasons why the business uses debt financing.

Reasons for debt financing

For expanding the operations and purchasing real estate- The banks usually extend their loan to the existing firms which have plans to buy real estate for expanding their operations. If the business wishes to expand, the banks know that they are successful and it happens only if the business is generating positive cash flow and profit.  In this scenario, the banks are likely to approve the loan. For the real estate purpose, the banks lend loan by accepting mortgages. Real estate would be used as collateral.

To purchase inventory- Banks often issue loans to the business to buy the inventories.  Few of the small business are usually seasonal in nature especially the retail business.  If at all a business makes maximum sales during the holiday season, then they will want to buy the inventory before the holiday season.  A bank loan is essential to stock up the inventories in bulk before the season arrives. These loans would be short-term in nature. The business will pay off these loans soon after the revenue is generated after the seasonal sale is over.

To increase the working capital- The amount of money which the business needs to conduct their day to day activities is known as working capital. In order to meet the expenses of daily operations, small businesses need to take a loan until they are able to sufficiently cover the needs of the working capital.  The banks support the business to start their operations and grow. As and when the business grows, they could repay back the loan to the bank. But the interest rate of the working capital is much higher when compared to other loans. The rate is high as the banks consider giving this loan is a riskier affair.