A simple guide to business loans and finance

The basics of business loans

What is a business loan?

There are several types of business loans in Australia including equipment finance (sometimes called a goods loan or chattel mortgage), invoice finance and overdrafts.

 

You can usually choose to pay either a fixed or variable interest rate and select a frequency of repayments that suit you – usually monthly, quarterly, or yearly. The regular repayment amount is typically worked out over a 1 to 30 year loan term. You can use different types of security such as cash, residential property, commercial property, or business assets to secure your loan. If you don’t want to put up security against a loan, you could consider an unsecured business loan, though these tend to be for smaller amounts.

 

What do you need a business loan for?

 

Business loans can help fund expansion and growth along with managing cash flow. A business loan may be suitable for your business if you need funding for things such as a business acquisition, start-up costs, capital investment, property acquisition or development, or refinancing other lending.

What types of business loans are available in Australia?

With so many loan options, it’s important to know your business needs and align them with the most suitable loan type. The options vary depending on: 

• Your business needs 
• The length of the loan 
• The terms of the loan.

Here are some common types of business loans:  

Business loan

A business loan is a lump sum of money lent to your business. The amount lent to you can vary as well as the loan term (the period in which you repay the loan), interest rate, interest rate type (fixed or variable), fees and security.

Some of the pros and cons of a business loan 

Potential benefits

• Flexibility of fixed or variable interest rates 
• Various repayment options (like principal and interest or interest only) 
• A defined loan term.

Potential disadvantages 

• The loan must be paid back in full in the agreed term 
• There’s no redraw option for fixed loans 
• The loan account can’t be used as a transaction account 
• Security is often preferred and linked to the loan.

Business overdraft facility/line of credit

A business overdraft is a type of line of credit that's usually linked to your business transaction account. You can access it when you need to spend or pay bills when you don't have enough money in your account. You reduce the overdraft/line of credit with the funds you have deposited back into the account when you can - as long as the overdraft stays under the approved limit. Interest is generally only charged on the money you use, not the total limit of the overdraft/line of credit. 

 

This type of business finance is typically used to relieve the strain on your cash flow, by providing funds to cover expenses (such as purchasing stock and paying invoices and wages) until you get paid by your customers.

Some of the pros and cons of a business overdraft 

Potential benefits

• Suitable for medium to long term seasonal cash flow requirements (such as busy stock purchase period, or need more staff during holiday periods) 
• Can be linked to your business transaction account 
• Doesn’t have an expiry date 
• Interest is only charged on the amount used.

Potential disadvantages 

• Interest rate is usually higher than business loans 
• Variable interest rates for the borrowed amounts apply 
• Doesn’t have the flexibility of repayment types (like interest only) 
• Doesn’t have a defined repayment schedule.  

Finance lease

A lease, also known as finance lease, allows you to use an asset (like a car, machinery or equipment) for an agreed period of time. The lender buys the asset at your request and it is rented to you over a fixed period of time (the term of the contract). Once the lease period ends, you return the vehicle or equipment and pay the residual value/balloon payment.

Some of the pros and cons of a finance lease 

• You don’t own the vehicle under your personal or business name - the bank owns the asset 
• The repayments may be tax deductible.

Commercial hire purchase

A hire purchase allows your business to buy assets over an agreed period of time. The lender buys the asset at your request and allows your business to use it in return for regular repayments. When all the repayments and final repayment is made, your business owns the asset.

Some of the pros and cons of a commercial hire purchase 

• You own the asset only at the end of the term 
• The interest on the finance and depreciation of the asset may both be tax deductible 

Chattel mortgage (goods loan)

A chattel mortgage (we call it a goods loan) is a popular type of business asset finance used to buy vehicles and equipment. With a chattel mortgage, your business buys and owns the asset from the beginning of the loan term and makes regular repayments for an agreed period of time until the loan is fully repaid.

Some of the pros and cons of a chattel mortgage (goods loan) 

• You have ownership of the asset/goods from the beginning of the term - if you want to upgrade to a new asset or good you will have to sell it yourself 
• The interest on the finance and depreciation of the asset may be tax deductible 

Invoice finance

Sometimes known as accounts receivable finance, this is a quick way to access cash to pay outstanding invoices. You can typically access up to 85% of the value of your approved unpaid invoices.

Some of the pros and cons of invoice finance 

• Helps to support cash flow 
• Outstanding invoices that aren’t due can be ‘sold’ to the bank for cash 
• Access up to 85% of the value of the invoice in cash (however, it also means you don’t receive the full value of the invoice that you have issued)  
• No security is needed as the invoice acts as security 
• Funds are usually received within 24 business hours.

How is interest calculated on a business loan?

In general interest is calculated on a per annum (p.a.) basis but is paid monthly. For example, if you take out a loan for $50,000 and the interest rate on the loan is 5%, the simple interest formula is: $50,000 x (5/100) = $2,500 in interest per year.  

To estimate your monthly interest, calculate: 

$2,500/365 x (no. of days in the month). 

Interest rates vary depending on a number of factors, take a look at Westpac business loan interest rates to get an idea of what to expect. 

Is a fixed or variable rate better? 

When choosing between a fixed or variable rate it helps to know the various pros and cons of each to work out which might suit your needs. 

 

Fixed rates are a great way to help manage your cash flow as your rate is locked in during the fixed period. This means you have certainty of repayments because your rates won’t change even if the RBA cash rate decreases or increases. However, during the fixed period you won’t be able to make extra repayments to your agreed monthly repayments without attracting fees and charges. There may also be break costs if you terminate your fixed period contract early.  

 

With a variable rate, the rate and repayments may change over the life of the loan. This means if rates go up you’ll have to pay more interest and your repayments will increase. However, if the rates go down you’ll pay less interest.  You’ll also have flexibility to make extra repayments to pay the loan off faster as well as the ability to redraw additional cash you have if this is an option for your loan.  

Fixed interest rate

With a fixed interest rate the interest rate of your loan stays the same for a specified period.  

What are some of the pros? 

• Fixed repayments – your repayments stay the same every month, which can give you more certainty throughout your loan term and make it easier to budget. 
• Automatic repayments – you can choose to set up automatic repayments for the life of the loan, so it’s one less thing to think about. 

What are some of the cons?

• Repayment costs – if you want to pay off your loan sooner, keep in mind you may be charged break costs and early repayment fees. 
• Future rate reductions and increases – another thing to consider is that if interest rates actually go down, you could miss out on a lower rate. If the rates go up you get to keep your lower rate until your locked in rate term has ended.

Variable interest rate

A variable interest rate may go up and down during your loan term.  

What are some of the pros? 

• Fewer repayment costs – you can make earlier or additional repayments or pay off your loan sooner without paying break costs. 
• More flexibility – some variable business loans act like a continuous line of credit. That means you can access any available funds if you need money for something else later on (there may be fees for this). 

What are some of the cons? 

• Potential interest rate rises – your repayments fluctuate with the interest rate, so you don’t have as much certainty and may end up paying more interest than you planned for. (Of course, the rate may go down as well so you could save money). 

The difference between secured and unsecured business loans

The main difference between a secured loan and an unsecured loan is whether an asset such as commercial or residential property, or other business assets are used as security against your loan.

Loans for business with security

A secured loan requires an asset to be provided as security. This may be property, inventory, accounts receivables or other assets. This security covers the business loan amount if you're unable to pay it back.

Some of pros and cons of secured loans

• Allows you to borrow against your assets like property, inventory, accounts receivables 
• Generally involve a longer approval process, as there’s security to consider 
• May need value assessments and additional proof and documentation of assets 
• Generally offer lower interest rates and higher borrowing amounts than an unsecured loan 

Loans for business without security

An unsecured loan doesn’t need physical assets (such as property, vehicles or inventory) as security. Instead, your lender will often look at the strength and cash flow of your business as security.

Some of the pros and cons of unsecured loans

• The strength of your cash flow may be used as security, instead of physical assets 
• Generally for smaller amounts 
• May be assessed quickly because no security is considered 
• Tend to have a higher interest rate than secured loans as they’re seen as higher risk 

Business loan guarantors

If you don’t have an asset to provide as security for a business loan, you may be asked for a guarantor or directors guarantee. A guarantee allows lenders to recover any outstanding debts from the guarantor if you can't make your repayments.

There are 2 types of guarantees:

First party guarantee: You guarantee the loan by providing security from an asset that you own, usually a property. This is the most common type of guarantee.

 

Third party guarantee: In some cases you’ll need someone else (a person or entity that is not you - the borrower) to guarantee your business loan. They’ll need to provide security from 1 of their assets.

If you can’t make your business loan repayments, the guarantor will be asked to pay them for you. In some cases, if the repayments aren’t being made, the guarantor may need to sell their nominated asset to cover the remaining debt, or offer further security.

Borrowing power: how much can I borrow?

To increase your borrowing power, many small business loans are secured by an asset – usually property. The amount of equity available in the property helps to determine how much you can borrow.

 

Equity is the difference between what you owe if you have a mortgage on the property and what the property is currently worth. You can estimate your equity by subtracting what you owe on your mortgage from the amount your property is currently worth.

 

Current property value – amount you owe = equity

Generally, we'll lend you up to:

• 80% of a residential property value
• 65% of a commercial property value
• 70% of a rural property value

Consider how lenders will view your credit score

Credit score also plays a part in borrowing power. A business credit score is a numerical indicator of the financial health of your business. This indicator is used by both banks and online lenders to assess your finance application and the risk in lending to you as a business.

 

It can be difficult to get approved for business loans with bad credit. But it may not be as bad as you think. Check out our article on how to find business loans with bad credit.

Business loan requirements and eligibility

There are several factors that can impact your business loan eligibility. Including your business history and experience, income, or capacity to repay a loan, business assets, security, collateral or capital and loan purpose.

1. History and experience

Your business trading history and experience help give lenders confidence in the sustainability of your business performance.

2. Income or capacity to repay a loan

When considering business loan eligibility, the lender is likely to expect evidence of how much money your business makes under recent and normal trading conditions. Be prepared to share your business and personal financial history. 

When considering your capacity to repay a loan, conditions such as a repayment schedule, interest rates and loan terms are key considerations when calculating your loan.  

3. Assets, security, collateral or capital

Providing collateral can help reassure lenders and having security assets may help lower the loan risk on the lenders' part. You could offer property, land, vehicles, or other assets as collateral to support your application. 

4. Affordability and conditions

Why do you want to borrow money? Is it to pay vendors/suppliers, for staff training, to expand your business, or even to handle litigation costs? Lenders need to know the details, the amount you would like to borrow, when you’re planning to commence repayments and term of the loan. 

How do you get a business loan?

1. Understand your finances and prepare a profit and loss or cash flow statement 
2. Put together a business plan outlining your financial situation and business goals 
3. Work out how much you need to borrow 
4. Choose a loan type – use our handy comparison tool to help you choose 
5. Submit an enquiry or call or drop into your local branch.

What documents will I need to apply for a business loan? 

To start the application for a business loan you will need: 

• At least 2 years’ worth of business and individual financial statements and tax returns 
• Proof of individual income 
• Personal statement of financial position 

As you go through the application process further documents and identification might be requested.