advantages and disadvantages of loans from financial institutions
If the cost of machinery is 5 times the company’s yearly net income, Company A does not have to wait for 5 years to expand. Bank loans provide an element of flexibility to the borrower, which can be very beneficial in long-term. This can make borrowing money an expensive decision and possibly unattractive as a financial option. The scope of a bank loan is vast, and the borrower can borrow as per their capacity depending on their creditworthiness. Failure to do so may reduce borrower’s credit score and future credibility. Even if you manage to make late payments, your bank could still report you to credit bureaus – a move that negatively affects your credit score. This type of loans is given by the developed countries to the developing countries. Organized and systematic bank loans are provided to borrowers with minimal interest rates. There various types of loan as per the needs of the customers. In addition, banks don't usually monitor how you use your loan as long as you make your payments on time, so you can invest it however you deem fit. The borrower can choose the duration of the loan and amount of EMI’s, whereas the amount of loan and interest rates are negotiable. (vi) Besides providing funds, many of these institutions provide financial, managerial and technical advice and consultancy to business firms; (vii) Obtaining a loan from financial institutions increases the goodwill of the borrowing company in the capital market. What’s your view on this? The repayment burden is a disadvantage compared to raising money through shareholders, because shareholders don’t require regular repayments. Failing to pay the loan amount on time can cause harm to your assured assets. Suppose an individual wants to buy a smartphone of USD 800.00, he decides to use his own USD 300.00 and borrow the rest USD 500.00 by bank loan at 10% interest per annum. If you are not reading this article in your feed reader, then the site is guilty of copyright infringement. Copyright 2020 Leaf Group Ltd. / Leaf Group Media, All Rights Reserved. Do you want me to help you ? A concessional loan is given either through below market interest rates, by grace periods or a combination of both. In some cases, they insist on the appointment of their nominees to the Board of Directors of the borrowing company. The banks have special loans that can help a company fund its day to day operational capital and cash cycle. Irregular Payment Amounts: If you get a bank loan with a variable interest rate, the rate changes with market conditions. In spite of all the drawbacks, bank loans remain the most basic source of funding for individuals and corporates alike. Start studying Financial Institutions Advantages and Disadvantages. For example, if you are paying a 5 percent interest rate on a $30,000 loan, then your yearly interest is deductible on your 1040 Schedule C tax form. If yes, the borrower should double check his need of a loan and the tenure for which he needs it. Nowadays loans are easily available to anyone by stable financial sources like banks, NBFCs, private institutions. This can result in wage garnishment and a negative mark on your record. Furthermore, even today bank loans are cheaper as compared to other loans from other financial institutions such as NBFC’s. This is especially true for fixed-rate loans, although a simple model can be prepared for changes in floating-rate loans.eval(ez_write_tag([[728,90],'efinancemanagement_com-box-4','ezslot_0',118,'0','0'])); With ownership perspective, bank loans can be a great source of funding for companies. It is always safe to take loans from financial institutions like banks and corporate societies as they have monetized terms and conditions and low rate of interest as compared to other money lenders. Financial institutions can lend more money than most friends and family members can. After all, what a great site and informative posts.Regards, Reader. In a secured loan, a borrower pledges some asset as collateral like property, car etc. Share it in comments below. In return, you pay the approved loan amount at a specified interest rate. (ii) Besides providing funds, many of these institutions endow with financial, administrative and industrial guidance and consultancy to business firms. Assistance is obtainable when recourse to usual sources is impossible or unbeneficial. These things add to additional compliances for the business apart from their daily administrative headaches. This makes it difficult to determine the exact amount of future payments. They lay down a convertibility clause in loan agreements. BankExamsToday – RBI Grade B Online Classes. The money lenders would usually exploit the borrowers by asking exorbitant interest rates and abnormal collateral demands. The interest on bank loans is deductible from taxable income, this is an advantage to the borrower in the form of tax savings. The major Disadvantages of raising funds from financial institutions are as given below: Restriction on dividend payment imposed on the powers of the borrowing company by the financial institutions. This is where bank loans come into the picture. A bank limit can support a business for such opportunities. Consequently, such a company can raise funds easily from other sources as well; (viii) As repayment of loan can be made in easy installments, it does not prove to be much of a burden on the business; (ix) Loans and guarantees in foreign currency and deferred payment facilities are obtainable for the import of required technology and equipment. (i) As these institutions come under government criteria, they follow rigid rules for granting loans. Commercial banks have a critical part in the general financial position of the economy as they give assets to various purposes and additionally for various durations. (ii) Financial institutions may have their nominees on the Board of Directors of the borrowing company thereby restricting the powers of the company. Banks have immense monetary assets and subsequently are dominant players in all sectors of financial markets like credit, cash, securities, foreign exchange and derivatives. Borrowing and lending have become a commonality in businesses in recent years, and bank loans are an essential part of this system. +Ifham Khan, Disadvantages and Advantages of JIO Sim Card, Disadvantages and Advantages of Maruti Suzuki Ciaz, Price, Disadvantages and Advantages of Honda Mobilio, Price, Disadvantages & Advantages of Samsung Galaxy A3, Specs and Price, Advantages and Disadvantages of Kawasaki Z250 SL, Drawbacks & Advantages of Samsung Galaxy A5, Disadvantages and Advantages Nokia XL, Specifications, Advantages and Disadvantages Samsung Galaxy Grand 2, Price and Specs, Disadvantages of Television, 5 Major Cons. However, in today’s fast-track economy, expansion is the only way to have sustainable profitability. This seems a minor amount but imagine the principle going in hundreds of thousands of dollars, then it can be quite expensive. The businessmen, before making a cash payment and availing the cash discount, must analyze the pros and cons. The Advantages of raising funds through financial institutions are as follows: Here, finance is accessible even during periods of depression, when no other foundation of finance is accessible in the market. Collateral removes the risks a financial institution takes on when lending out large sums of money (a house mortgage or car loan, for example). eval(ez_write_tag([[250,250],'efinancemanagement_com-medrectangle-3','ezslot_1',116,'0','0']));Bank loans are major drivers of growth, especially for public and private sector companies. Interest rates also fluctuate. Her work has appeared in “U.S. Thus in total, he paid USD 850.00 for a product priced at USD 800.00. Very few companies may have enough cash flow for financing huge expansion. Advantages and Disadvantages of Financial Institutions. With a lower score, obtaining loans in the future becomes more difficult. Thanks for sharing this very helpful and informative article. For example, if an individual takes home loan from the bank, he can decide if he wants to repay the loan in 5, 10 or 20 years. Too many formalities make the procedure time consuming and expensive; (v) Certain restrictions such as restriction on dividend payment are imposed on the powers of the borrowing company by the financial institutions; (vi) Financial institutions may have their nominees on the Board of Directors of the borrowing company thereby restricting the powers of the company. Since most creditors allow cash discount, the benefit of which can only be derived when you have funds available to pay. The healthy developed economic organism helps the business to accomplish development by making funds obtainable to them. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms". Meaning: A loan is the lending of money from one source to another source for a specified period. Though these loans are helpful for many people but they have some severe disadvantages. Copyright 2020 Leaf Group Ltd. / Leaf Group Media, All Rights Reserved. Small companies who are new to the business and have not taken any bank loans in the past find it even more difficult to obtain a bank loan. The lower interest rates of bank loans will definitely save you money. It can borrow a term loan from the bank to fund its expansion plans and repay it over the next 5 years, thereby accelerating growth. This, in turn, makes the loan less expensive in the long run. Even though anyone can potentially use the financial services of traditional banks, these financial institutions often offer loans at high interest rates. He repays his loan after one year, whereby he has to pay the principal amount of USD 500.00 + interest payment of USD 50.00 (10% of USD 500.00). Advantages and Disadvantages of Bank Loans, Click to share on WhatsApp (Opens in new window), Click to share on LinkedIn (Opens in new window), Click to share on Facebook (Opens in new window), Click to share on Twitter (Opens in new window), Click to share on Pinterest (Opens in new window), Click to share on Skype (Opens in new window), Click to share on Tumblr (Opens in new window), Click to share on Telegram (Opens in new window), Click to share on Reddit (Opens in new window), Click to share on Pocket (Opens in new window), Click to email this to a friend (Opens in new window). (iii) Sometimes, these institutions place restrictions on the autonomy of management. IMF have come to the aid of several nations who are facing the challenges of eminent economic total collapse. As such, you will retain all your business profits. Whereas in a bank loan, the company can raise funds as well as keep the ownership. Loans backed by collateral, also known as secured loans, offer lower interest rates but present the clear danger of losing your property. He also holds a Master of Arts in American Indian studies. A strong credit score and favorable market interest rates produce a favorable borrowing environment. (x) Along with finance, a company can obtain specialist guidance and direction for the successful planning and management of projects. Notify me of follow-up comments by email. © copyright 2020 QS Study. IMF loans help nations to embark on developmental projects that would have been impossible for them because of financial constrain. The benefit derived out of the cash discount should be more than the cost involved in terms of interest on the funds. Pros & Cons of Borrowing Money From a Financial Institution. If the borrower doesn’t have sufficient funds for partial payment, then the bank may reject the loan application. A loan is the lending of money from one source to another source for a specified period.
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