Debitoor's accounting dictionary

Loan - What is a loan?

In financial terms, a loan is a sum of money that an individual or entity borrows from another individual or entity, in exchange for future repayment of the full amount plus any interest charged.

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As the recipient (the one borrowing the money), when you take out a loan you are also taking on a debt by becoming liable to repay the principal amount borrowed within the agreed time frame provided.

Loan for your business

You probably all know the saying “You have to spend money to make money”? Well, in many cases this is actually true!

Taking a business loan is quite commonly done to assist new businesses getting started, or even to help expand or grow an existing business.

When starting a business, in order for it to grow or expand you need to be able to invest into areas such as marketing, equipment, property, advertising etc. But how can you invest into the business if you do not have the funds for it?

There is no right or wrong answer to this question, and they are actually a number of different and creative ways to fund a new business. One of the most traditional ways, however, is to take a business loan.

Taking a loan for your business can be a great solution to help you cover the extra expenses involved when expanding your business, without having a heavy negative impact on your operating profit.

Types of loans

Banks are the most common loan providers, and the incentive behind lending out money comes from the interest they will receive in addition to the full repayment.

There are many different reasons as to why one might apply for a loan. For that reason, banks offer a variety of different types of loans to ensure they match all your needs.

A loan can be either in the form of secured or unsecured:

A secured loan is backed by collateral, and is typically a large sum of money. Secured loans are long-term meaning a longer repayment period, and interest rates are typically low. In the case of default, secured loans have a security of the lenders assets.

An unsecured loan on the other hand is not backed by collateral and typically consists of smaller amounts of money. Unsecured loans are short-term, and have no guarantee attached. Therefore, to compensate for the higher level of risk in this type of loan, interest rates tend to be higher.

Some common types of loans include:

  • Mortgage loan
  • Student loan
  • Car/auto loan
  • Business loan
  • Personal loan

Each loan type will have different terms and benefits tied to them, so you will need to compare them respectively to decide which is best suitable for you and your needs.

What to consider before taking a loan

Before apply for a loan, you need to consider whether this is the right thing for you.

Borrowing money is a big responsibility to take upon yourself, and you need to make sure that you will be able to repay back the full amount plus interest or any other financial charges.

If, for some reason, you are unable to pay back the loan (or if you are able to pay it back but not within the agreed time period) then you risk facing penalties, and that could get ugly. These penalties could be anything from higher interest rates, to claiming your assets and bad criminal records.

In order to avoid getting to this point, you need to make sure you are able to make the necessary repayments every month on the exact due date and no later.

Managing your finances

No matter whether you decide to take a loan for business reasons or for personal reasons, you need to be prepared to take on that liability.

Online invoicing and accounting softwares such as Debitoor help you implement an effective accounting system to record all income, expenses, and all other financial activity of your business - whilst also accounting for a loan. This can help you keep your business finances in order, and make sure you have a good overview of your business financial position at all times!

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