Debt is essentially a loan - an amount of money borrowed from a creditor. The amount borrowed is usually evidenced by a note, signed by the borrower, agreeing to repay the principal amount borrowed plus interest.
The terms under which money is borrowed varies widely. Short-term notes can be issued for periods as brief as 10 days to fill an immediate need. Long-term notes are issued for a period of several years. In some case, particularly in short-term borrowing, the total amount of interest due over the term of the note is deducted from the principal before the proceeds are issued to the borrower. Such a note is called a discounted note.
Some of the terms available are:
Short-term Borrowing
Short-term borrowing usually requires repayment within 60 to 90 days. Notes are often renewed, in whole or in part, on the due date, provided that the borrower has lived up to the obligations of the original agreement and the business continues to be a favorable lending risk.Credit Lines
When a business has established itself as being worthy of short-term credit, and the amount needed fluctuates from time to time, banks will often establish a line of credit with the business. The line of credit is the maximum amount that the business can borrow at any one time. The exact amount borrowed can vary according to the needs of the business but cannot exceed its established credit line. One nice feature of a line of credit is that you pay interest only on the actual amount borrowed, not the entire line of credit available.Long-term Debt
Long-term debt is borrowing for a period greater than one year. A subclassification which is often used is intermediate debt which is borrowing for periods of one to 10 years.
When the terms of a debt are negotiated, a payment schedule is established for both interest obligations and principal repayment. The dates on which principal and interest payments are due should be scheduled carefully. For example, a manufacturer with heavy sales just before Christmas and receivables collections through January might best be able to schedule repayments in February. If a payment were due in October or November, when inventories were high and receivables were climbing, the payment could be crippling.
Mortgage Loan Repayment Schedules
Principal and interest payments on mortgages usually involve uniform monthly payments that include both principal and interest. Each successive monthly payment reduces the amount of principal outstanding. Therefore, the amount of interest owed decreases and the portion of the monthly payment applicable to principal increases. In the early years of a mortgage, the portion of the monthly payment applied against the principal is relatively small, but grows with each payment.Term Loan Payment Schedules
For term loans, payment of principal and interest is ordinarily scheduled on an annual, semiannual or quarterly basis.For example, a 5-year, $50,000 term note bearing 10% interest might have the following payment schedule specified in the note agreement:
End of Year Principal Repayment Principal Outstanding Interest Payment @ 10% 1 $10,000 $50,000 $5,000 2 $10,000 $40,000 $4,000 3 $10,000 $30,000 $3,000 4 $10,000 $20,000 $2,000 5 $10,000 $10,000 $1,000
Commercial banks are the normal source for short-term loans for small businesses. Borrowing capital for periods longer than 10 years is usually available only on real estate mortgages. Other long-term borrowing usually falls into the intermediate classification and is available for periods up to 10 years. Such loans are called term loans.
The type and term of the loan should be based on the purpose for which the funds will be used. Your banker or accountant can help you determine what type of loan is best to meet your needs. If you have some type of collateral, obtaining a loan is much easier because there is less risk to the lender.
The interest rates at which small businesses borrow are often relatively high. Banks and other commercial lending institutions normally reserve their lowest available interest rate, the so-called prime rate, for those low risk situations such as short-term loans for major corporations and public agencies where the chances of default are slim and the costs for collection, credit search, and other administrative tasks are minimal. Because of the higher risks involved in loaning to small businesses, lenders often seek greater collateral while charging higher interest rates to offset their added costs of credit search and loan administration.
