The dream of any company is to always be able to walk with its legs and, in that sense, using resources from its cash to pay operating expenses and make investments can be the best way. But whoever is in the day-to-day administration, like the controller, knows that this is not the case in many cases.
Seeking resources is a common movement and it does not always indicate a problem, however, it can be a red light for those companies that need to resort to financial aid because they do not have a business budget and have gone beyond cash. It is then, that the loan or financing options to meet the needs of each business arise.
However, before looking for one of these options, it is necessary to know them. Do you know the difference between loans and financing? Do you know the characteristics and advantages of each modality? To help you, we have prepared this article, which explains the main details of these two credit alternatives, talks about the pros and cons, and gives some important tips for the moment of decision making.
Difference between loan and financing
Sometimes, the definition of these concepts generates some confusion, but the fact is that, although both are credit operations, they have some differences, mainly in the function they perform for the company’s cash. They are also distinguished in the way they are contracted, in the size of interest, and other particularities. Look:
What is a business loan?
The loan is a model of credit operation in which the financial institution grants the amount without requiring the company to justify the destination of the money. Whoever hires is free to use the resource taken in the way they see fit, needing only to return the amount on time and with the interest previously agreed.
In lending to companies, the institution also does not require any type of guarantee in exchange for money, such as a machine or a property. The agreement, formalized in a contract, then becomes the only way to provide security to the credit-taking process. Thus, this model has become widely used because it has little bureaucracy as a characteristic.
However, the absence of these requirements that we have mentioned directly impacts the conditions under which loans are granted. The main one is in the interest rate charged. This is because the guarantee is how the financial institution ensures that, in some way, it will receive back the funds it lent, even if they return in the form of some asset. Without this item in the contract, there is an increased risk that the debt will not be repaid. The way used to increase protection, therefore, is to increase the interest rate.
It is not a rule, but it is still common for loan sources to offer shorter payment terms. This also has to do with the insecurity generated by the lack of a guaranteed requirement.
What is business financing?
In business financing, those requirements missing from the loan model appear as the main characteristics. The most important of these is the need to tell the financial institution where the resource will be applied, in addition to explaining the reasons why a credit operation is being used. So, if the company financed a certain amount to buy two machines, for example, it is this amount that must be spent and these are the goods that must be purchased.
The other condition that appears when financing sources for companies release the values is the guarantee. In most cases, the property itself is usually placed on the contract as collateral. In our previous example, the two machines would be taken by the financial institution as compensation for possible default.
With the guarantee as part of the contract, the financing risks for the institution decrease. As a result, interest rates also fall and deadlines for payment of financed amounts go up.
On the other hand, the bureaucracy involved in the financing release process also grows considerably and the company needs to present documents such as budget, balance sheets, and the Income Statement for the Year (DRE) – which is why it is important to keep these documents and reports always up to date and available for use. Thus, the institution analyzes the business situation and the ability to pay the debt.
How to know which option is best: loan or financing
The option to be chosen is directly linked to the company’s needs at the moment. And that is why planning and finance professionals need to do a detailed analysis to identify this point accurately.
In general, the business loan, because it has less bureaucracy and shorter release time, serves more for specific day-to-day issues of running a business, such as adjusting cash flow, paying an important supplier, or paying off a debt that can hinder the company’s health.
Imagine that an organization has obtained an important raw material discount from suppliers, but does not have cash on hand at the moment. If the deal is worthwhile and the discount given by the supplier compensates for the interest payment to a financial institution, a loan may end up being a good solution at the moment.
In turn, business financing has, in theory, a long-term character, being more linked to business planning. Companies often use this model of credit operation to, for example, buy new equipment and apply an expansion plan. It is very common, especially in large companies, to use financing to make expansion and improvement plans feasible, even when the company has excess capital in the cash.
Speaking of investments, they demand from the controllers a serious analysis of the numbers of the business. To help you with this matter, we have an e-book that talks about the financial indicators used in the analysis of possible investments.
It is natural that any company, at some point in its trajectory, needs to seek external resources to solve a problem or make an investment. But this must always be done with great intelligence and the utmost care. Any inattention in a credit operation can cause great losses to the business.
So, before taking out a loan or financing, ask a simple question: do I need that money? You can be sure that this question will make you reflect better on the step you are taking in the company’s finances.
Then, when obtaining the resources, it is important to pay close attention not to fall into any holes. Check the suitability of the institution you are hiring, carefully analyze the contract, the stipulated conditions, and requirements. Every detail can make a difference at that moment.