People who are at least a little familiar with the sphere of small and medium business know well what a commercial loan is, how it differs from a loan from a bank and what disadvantages and advantages it has. Commercial loans to some extent are a way to adapt any business to a difficult economic situation. If the bank lending system is more focused on building a business base (especially small business), then these loans help reduce the regular costs of firms, as well as prevent unforeseen situations.
Basis of mutual lending to legal entities
The essence of a commercial loan lies in the fact that here the instrument of lending is not cash, but goods and / or services (depending on the type of activity the company conducts). Moreover, the lender and the borrower may be any party. A wholesale supplier of goods / services may become a beneficiary, and a purchaser company may become a borrower. As well as the buyer can “issue” loans of a commercial type, and the party supplying him the goods / services will act as a borrower.
The provision of a commercial loan, according to the general scheme, is two-variant:
- The supplier (seller) provides its product to the buyer, but does not charge for these goods / services at this particular moment. The buyer uses the received product within his business, and transfers the money to the seller later, including some additional amount for such an assignment. This is a commercial form of commercial credit.
- The buyer partially or fully makes money for the goods / services, but does not immediately receive them, but only after a certain period. Sometimes the cost of goods purchased here in advance is reduced, because now the buyer provides services to the seller, providing money in advance. The second option is a monetary form.
The main reason for the emergence of this type of lending is that firms operate in different cycles. For example, when one company has a time to sell products, another company is just beginning to produce these products. Commercial lending is different in that it lacks the familiar participant in lending as such. It’s about the bank. Such transactions can be carried out by any legal entities related to each other by the main contract of entrepreneurial activity. Usually, if commercial plan loans take place in business partner transactions, they are recorded as part of the main contract.
Differences from bank loans
In other cases, an additional commercial loan agreement is a necessity, and therefore is drawn up separately. In this case, the same rules apply to it as to the main contract. For example, a basic state registration agreement is required, which means that an additional one will also have to be registered. The conclusion of the described transactions between enterprises is governed by the 823rd article of the Civil Code. It is reasonable to give a comparative table, where the terms of a commercial loan are considered alongside the terms of a conventional bank loan:
Lender and borrower – legal entities related by business contracts
Borrower – any person engaged in business, but a loan is issued only by a specialized financial entity (bank)
Loan subject – goods / services
The subject of the loan is money
Low interest rate
High interest rate
The party that takes the loan, the costs of additional payments for it covers by increasing the price of goods / services to the end user
Determining costs are fixed annual interest.
Subtleties of alternative lending
Separately, you can mention the timing of a commercial loan. The period of the average credit agreement between the subjects is always much shorter than the term of a standard business loan. This is explained by the fact that both sides are doing business, in which any delays are fraught with costs. The parties are always interested in paying off mutual obligations as soon as possible. In addition, the peculiarities of the business itself may affect the term of a commercial loan. If the work of the company is related to seasonality, then the period of a commercial loan will depend on the time of year. Most often, such things are observed in the field of agriculture and crafts. The special fact is that the overpayment on a commercial loan is much lower than on a bank loan. The reasons are as follows:
- Money, even within the framework of a target loan, is a far more universal capital than most goods / services (rare exceptions are precious metals, real estate, etc.). Therefore, when a loan consists in providing goods or money for goods, the whole service is just a delay. For such a high fee you will not need, but banks provide a universal tool for business – large sums of money.
- Purchased goods / services are almost always included in the list of costs of the company, i.e. it is just a borrowed working capital. But even banks do not put high interest rates on loans aimed at solving small, regular problems of the company.
- A commercial loan has a very interesting feature – both parties are almost always interested in it – the lender and the borrower. Supplier-seller, lending goods, will not spend money on warehousing, and the buyer will be able to close the gap in working capital on time. The buyer is often interested in buying the goods that are not yet ready (because of the rarity of the goods, the seasonality of its use, etc.), and it’s easier for the seller to get money before.
That is, a commercial loan operates in the best traditions of the “game theory” of John Nash – each acts simultaneously for the benefit of itself and for the benefit of the partner (s). This is one of the main advantages of a commercial loan, from which most of the other advantages of this form of lending stem. Although, as elsewhere, there is a set of advantages and disadvantages, but they will be discussed below. When banking financial assistance is not established, entrepreneurs are saved by such mutual assistance. Forms of commercial loans can be the following:
- deferred payment – when the supplier-creditor ships its product, but takes the money (in a single amount) from the borrowing company through a mutually agreed upon period of time. For this period of delay, the goods are considered mortgaged by the seller as a guarantee of the return of material resources. A small percentage of the payment deadline may be charged both on days of deferment and at the market value of the goods (determined by agreement of the parties);
- installment payment of goods – here everything is the same as in the previous paragraph, only the buyer makes the money not in a lump sum, but in several visits on predetermined days. The issued loan is considered repaid after making the last payment;
- advance payment (partial payment) – the lender-buyer pays in advance for the goods that have not yet been received, and not in full (one third, half of the cost). After some time, the supplier provides the promised product, and the buyer pays the rest of the amount (the interest for the borrower-supplier is the fact that the price of the goods is reduced);
- full payment – the difference from the previous point is that the buyer gives the seller all the money in advance for the goods that have not yet been delivered. In this case, the seller has to make a slightly higher discount.
Variants of debt registration for this type of loans
The definition of a commercial loan as the mutual consent of two legal entities regarding the provision of goods / money in advance for goods justifies the variety of ways in which such debt is generated:
- Bill of exchange As a borrower, the buyer issues a special financial document to the seller, indicating the obligations of the buyer to the seller. The borrower is obliged to pay the bill on time, that is, to give the seller the amount due for the goods, taking into account the interest. The bill implies payment exclusively in cash.
- Opening an account. The beneficiary-seller allows the buyer for a period to take the goods without paying for them. That is, opens a debt account. This is convenient when the buyer does not know exactly how much and when exactly he will need the goods / services. When the loan period ends, the seller issues the resulting invoice to the buyer, and the latter pays for all goods / services that were purchased during this period (including interest). That is, an account is opened and then closed after payment for services.
- Discount when meeting the terms of purchase or cash discount. If the buyer is permanent, reliable and he needs the product of the supplier-seller almost always at the same time, then the supplier can offer the customer a discount. Provided that the goods will be bought exactly on the agreed date.
- Seasonal lending or franchise. As such already mentioned. Supplier delivers its product before the season when it will be used by the buyer. After the seasonal implementation of a cash settlement. As already mentioned, the seller thus avoids the financial burden associated with the storage of their product.
- Consignment This method is very convenient for the buyer. The bottom line is that the product is taken from the seller in debt, but without the obligation to pay for the entire product. For a period of time, the buyer puts the product into circulation, and at the end only pays for the part spent. The remaining surplus goods must be returned safe and sound to the seller. The method is distinguished by its economic advantage, since it allows to avoid empty financial costs.
Despite the fact that the lender is not legally bound in terms of setting the interest rate and is interested in the successful entrepreneurship of the second party, there are a number of restrictive requirements:
- the interest rate must necessarily be less than in a similar offer from the bank;
- since the cost of paying the debt raises the price of the final product going from the borrower to the consumer market, they should not be too high for the price of goods to allow them to compete with their counterparts in the market;
- but at the same time, the costs of the lender must also be fully leveled by the interest that the borrower will pay.
Pros and cons of commercial loans
It can be seen that the advantages of a commercial loan are numerous: small overpayments due to a small percentage, but thanks to this percentage, the creditor side receives additional profit; the borrowing party resolves temporary obstacles in the business; simplicity and speed of execution of the loan agreement; mutual benefit and in general a positive impact on the development of business and the economy, especially small business. Thanks to the development of such a non-bank credit market, goods turnover is optimized, and cash costs are falling. The mobility of market entities is growing, which is of paramount importance for their survival.
Among the shortcomings of a commercial loan is to highlight its limitations in monetary terms. This is due to the supplier’s commodity limit and the buyer’s payment options.
Each side is still a bit, but at risk. The seller may not receive money for the supplied and already realized goods due to the buyer’s bankruptcy. The buyer risks losing the money given out if the goods are not produced, delivered, or shipped at the right time. Of course, the seller must return the money in such circumstances, but then the seller is not insured against bankruptcy. Just as no one is immune from scammers who are attracted to the sphere of commercial loans. Here it is easier to get material values through dishonest means than from a bank. Actually, this is why loans of this type are common for the most part in the field of small business. Large market players almost never “drop” to such transactions, preferring to attract reserve, secondary, emergency capital in case of difficulties.
Another property, which, depending on the state of affairs, is considered as a disadvantage, then as an advantage, consists in a small time interval for which commercial loans can be issued. On the one hand, such loans cannot be otherwise, because they are due to the need to keep the business afloat in a period that fits within the calendar year. But sometimes the business cycle can take two and three years. Then it becomes more difficult to issue commercial loans.
The third minus of the loans under consideration is associated with bills of exchange. Their use connects the banking system to the relations of legal entities, which is not always good. For example, this leads to an increase in monetary currency, since bills of exchange are considered securities. It also enhances the indirect pressure of banks through the system of lending to legal entities. Banks are generally not particularly interested in the development of commercial loans, because it sometimes reduces the demand for short-term business loans. Today, many people are engaged in business. And to know the main points of such an important “engine” of this activity is simply necessary.