Setting up a business is not easy and requires a considerable amount of time, effort, and resources. Businessmen may often feel the need to establish a company that can satisfy a need in an efficient means, but they may not have the resources to go about it. Well, commercial credit is a simple and wonderful solution that can help you solve a myriad of financial problems, from buying a home to tuition fees. Credit allows people to buy things they need and want but cannot make full payment upfront.
A person or a business entity borrows money and then agrees to make the payment within the given time period. Many businesses and consumers use credit facilities that help streamline transactions and boost the economy.
For a startup company, credit allows it to access the tools and resources needed to establish and grow a business. Without a credit option, it can be hard for a company to source raw materials, equipment and pay workers in these fast competitive times.
What is Commercial Credit?
Most loans and credit are given by banks that usually make money by taking funds in the form of low cash deposits and then loan the same money at a higher interest rate.
Commercial credit is defined as the pre-approved amount of money issued by a bank to a business company or individual to help meet financial obligations. Commercial credit is also called a ‘commercial line of credit’ and is mostly used to help perform day-to-day operations and be repaid when available.
For example, a clothing brand has an urgent need for a particular equipment to meet the additional demand. The clothing company can get the required funds through a commercial credit agreement offered by a bank.
However, to access a loan, the business company has to go through a ‘Credit Approval Process’ where the bank determines if the proposed loan to a company can be timely repaid or not. A denied or rejected credit application can always be redefined to avoid risks.
Commercial credit solutions include a wide variety of short-term and long-term business loans. The loan can help business companies to streamline their working cash flow requirement, purchase inventory, finance the purchase of capital assets, and maintain working capital.
The Different Types of Commercial Credit
The advantage of commercial credit is that the company only needs to pay interest on the money drawn and not on the complete loan amount. For example, if a company got pre-approved commercial credit of $200,000 but only took out $50,000, then it would need to pay interest on $50,000 and not on $200,000.
The two popular types and commonly used are secured commercial credit and unsecured commercial credit.
The secured commercial credit is a loan amount that is issued based on collateral. If the borrower cannot repay the loan. Then the lender can take the collateral and liquidate it for cash or use the cash to clear the debt amount. The type of assets that serve collateral for a business includes inventory, accounts receivable, and capital assets.
Unsecured commercial credit is a loan amount that is not based on any collateral but issued with a high-interest amount as this type of credit increases risk for lenders.
Applying and getting credit is also useful to improve credit reports. When an individual or business borrows money, the credit reporting agencies such as Experian, Equifax, and TransUnion evaluate the performance. The credit score is determined based on the amount borrowed and whether it was paid on time.
The Short and Long Term Commercial Credit
Lenders then use the credit scores to judge the financial ability and history of a person to repay the loan or not. If you are an entrepreneur wanting to establish a startup business. Then your credit score would be vital to determine whether you can apply and get commercial credit or not.
Commercial credit or business loans are both offered for the short term and long term.
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Short Term
The short term loans include lines of credit and accounts receivable loans
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Lines of credit
A line of credit is a loan that can be drawn up to a certain credit limit. This type of loan is ideal for short-term needs such as working capital or increasing the inventory to meet the demands. More money can be drawn if the repayments are made on time.
A line of credit can also be taken to meet the operating expense. Most contractors and manufacturing companies get these loans, and both repayment guidelines and collateral are based yearly and according to the company’s financial health.
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Accounts receivable loans
The account receivable loan helps the company fulfill the monthly operating costs when the payments from customers are yet to come.
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Long Term
Business companies require long-term commercial credit to fulfill long-term goals such as business growth and expansion or setting up infrastructure. The loans are sourced upfront and then repaid over a specified time, from 5 years to 10 years. The long term loans are secured with inventory, cash, equipment, or another type of securities.
A company may perform ‘commercial credit analysis. Which is done to determine its ability to fulfill its financial matters and obligations. Credit analysis may also help the bank know the company’s ability to timely make the loan repayment that includes both the principal amount and interest payments.
The banks of lenders may provide a risk rating, which tells if credit can be provided to the borrower and its amount.