One of the most popular sources of funds to finance the working capital, expansion, equipment, or a new project are business loans. The knowledge about your business lending EMI (Equated Monthly Instalment) assists you in managing your cash flow, selecting a suitable product and being awarded their due tax treatment. The guide entails EMI calculation, lending to businesses, eligibility, prepayment strategy, refinancing, tax and accounting notes and practical FAQs that are specific to business borrowers in India.
What is a Business Loan EMI?
An EMI (Equated Monthly Instalment) is a fixed monthly payment provided to the lender until the loan has been paid off. Each EMI includes:
Principal
Part that lowers this amount borrowed and lessens your amount of responsibility.
Interest
Interest rate that the lender charges in the provision of the financing.
Business Loan Structures
Business loans can be arranged to have a fixed EMIs, reducing balance EMIs or flexible interest-only (typical with project finance or seasonal working-capital lines). You should always know your particular repayment arrangement.
Common Types of Business Loans
Term Loan
To grow, expand or capex; fixed tenure and EMI with organised repayment term.
Working Capital
Revolving overdraft/cash credit, which is adjusted to cashflows; interest chargeable on amount used.
MSME Loans
Government-supported subsidised or reduced rate products to the eligible micro, small and medium enterprises.
Equipment Finance
Purchases of equipment through asset backed loans; tenor usually based on useful life of asset.
Invoice Discounting
Receivables-based finance Short-term finance works differently, compared to standard EMIs.
Unsecured Business Loans
Its processing is quicker and at higher interest rates, and has shorter tenures and is non collateralized.
The Major variable players in your business loan EMI.
Loan Amount & Tenure
The cost and amount of repayment are directly proportional to the principal and the duration of the repayment.
Interest Rate
Cost driver largest even minor changes in rates compound considerably during the term of the loan.
Repayment Structure
Fixed EMI vs interest-only periods influence future cashflow and the total interest paid.
Cash Flow Predictability
Lenders charge risk depending on the consistency of the turnover and the health of receivables of your business.
Collateral & Guarantees
Facilities that are secured by collateral typically come at low rates as compared to unsecured ones.
Business Credit History
By having improved business and promoter credit profile, better pricing and increased credit limits are offered.
Business Loan EMI Should be calculated how?
The lenders common EMI formula:
Practical Example
Eligibility, Documentation & Credit Metrics
Typical Eligibility Checks
Business Vintage
Majority lenders demand 2-3 years of financial stability in operation of business.
Financial Performance
The critical points are profitability, growth of the turnover, and stable revenues.
Credit History
Promoter credit history and business credit score play a major role in approval and rates.
Business Registration
GST registration, incorporation documents and Udyam/MSME registration where necessary.
Common Documents Required
Identity & Address Proof
PAN, Aadhaar, passport of promoters and business address verification documents.
Business Proof
GST registration, incorporation /firm registration, Udyam/MSME certificate, shop establishment license.
Financial Documents
Bank statements (6-12 months), audited account, P&L statement, balance sheet, ITRs.
Project Documents
Quotations/invoices of capex loans; collateral documents of secured lending.
How to Streamline Affordability and Loan Construction
Match Tenure to Asset Life
In equipment loans, make sure that tenure matches useful life to eliminate future negative cash flows.
Prefer Secured Lending
Systematic collateral that is pledged usually lowers the interest and also enhances the terms of the loan.
Negotiate Pricing & Fees
There are differences in processing charges, renewal charges and prepayment terms - compare overall cost.
Manage Cashflow Commitment
Stress-test Keep EMIs within manageable percentage of operating cashflow.
Staggered/Balloon Structures
Think about staggered or balloon payment structures to project financing whereby there are limited cashflows at the beginning of the project and thus smaller initial payments are made with an increasing amount as the project actually generates a revenue.
Prepayment & Foreclosure (Business Context)
When there is excess cash, then different businesses usually prepay. Knowing your alternatives and consequences is of paramount importance in financial planning.
Part-Prepayment
Advantages
- Decreases unpaid debts
- Choice to minimize EMI or decrease tenure
- Reduces interest weight slowly
Considerations
- May can be frequency or amount restricted
- There are processing fees that are charged by some lenders
- Check specific lender policies
Foreclosure
Advantages
- Pay off all outstanding balance
- Close loan completely
- Eliminates interest expenses on future
Considerations
- May is a draw to foreclosure fees
- Common for commercial loans
- Limitations on the check lock-in period
Cash Flow Strategy
Financial discipline and reducing interest more quickly are commonplace with businesses with changeable cashflows whose performance is better maintained with a buffer and favored with shorter tenure (as opposed to a complete EMI cut).
Important Note
Multicareful with check lender prepayment and lock-in. There are also commercial loans which have a higher rate of penalty or shorter length of time to prepay which may affect your financial planning.
Refinancing / Balance Transfer Guide
It is good to refinance when a new lender proposes significantly lower interest rate and the refinance cost is less than the savings projected.
When to Consider Refinancing
When the market situation or your credit background changes, businesses can refinance their term loans, equipment loans or their working limits to secure improved pricing, tenure or to secure better terms.
Refinancing Process
Cost-Benefit Analysis
Compare Net present value (NPV) of future cashflows at present loan vs refinance after all charges.
Check Eligibility
Make sure that your business fits the requirements of the new lender such as credit score, financial performance and paperwork.
Calculate Net Savings
Include the charges of transfer fees, processing money, legal fees and stamp duty to ascertain real savings.
Complete Documentation
Send necessary business and financial documents to the new lender so that they are approved.
Tax and Accounting Treatment (India)
Interest Paid
Tax Treatment
- Generally qualified as deductible business expense
- Deductible in Section 37 of Income Tax Act
- Needs to be properly documented and put into business
Principal Repayment
Accounting Treatment
- Not a deductible expense
- Clears outstanding liability on balance sheet
- Considered as the payment of loan capital
GST & Other Charges
GST might have to be imposed on processing fees or other service charges based on the nature of the service and invoicing — refer to your accountant on applicability and compliance.
Documentation Requirement
Interest on loans borrowed with the purpose of doing business is mostly deductible business expenses as long as the funds are applied in the bona fide business operations and adequate books/evidence is kept. Check with your tax consultant on the details and documentation.
Common Business Loan Mistakes to Avoid
Over-borrowing
Borrowing as much as possible, without adequate cashflow stress-testing and repayment capacity analysis.
Ignoring True Costs
Ignoring processing fees, renewal fees, and effective interest rate (APR) in loans comparisons.
Tenor Mismatch
Credit financing of long-term capital expenditure with short-term credit imposes a strain on repayment and a risk of re-finance.
Mixed Accounts
Failure to maintain business and promoter personal transactions on separate accounts makes accounting and compliance difficult.
Contract Neglect
Failure to carefully read the loan agreements particularly the prepayment terms, the security fees or charges and the terms of default.
Collateral Over-commitment
Giving too much security that restricts the future borrowing and the flexibility of the business.
Single Lender Dependency
The failure to diversify banking relationship with more than one bank.
Poor Utilization Planning
Failure to have a proper strategy on how to use the loans and follow up on them resulting in poor use of capital.
Frequently Asked Questions
Yes - you can claim interest as a business expense on loans taken out to be used in the business provided the conditions and the documentation to the taxing law. The repayment of principal is not deductible. You should never lose track of records and you should seek advice on a particular case with a tax professional.
The widely varying rates are dependent on the lender, type of loan, and collateral and the borrower profile. MSME loans secured and guaranteed by government can begin at a low (single-digit in some cases) amount, and unsecured business loans can vary considerably higher. The reported standard business loan rates in the commercial market typically range between the low-teens and mid-20s percentage per annum based on each product and credit profile. Always demand an APR/total-cost quote of the lenders when making decisions.
Take term loans to use in capital expenditure and expansion (fixed EMI, tenor matched). Short-term liquidity and operational requirements should be met by using working capital (overdraft, cash credit, invoice discounting). Never finance long term assets with short term revolving finance because this leads to maturity mismatch.
The lenders vary greatly in policies. Part-prepayment is permissible after a lock-in period in some of them and penalties may be charged or limited. Read your particular loan terms and bargain good terms of prepayment during the origination.
With audited financials, GST and bank statement performing stable collections, a low number of receivable days being recorded and a specific business plan or project report on capex loans, it will be ensured that better interest rates and bigger facilities are obtained. Good credit history and collateral also enhances pricing.
Yes - there are a number of schemes that facilitate MSME lending such as credit guarantees, subsidised rates and margin-money subsidies. The scheme features and eligibility vary, visit government portals and bank websites to see the existing schemes such as CGTMSE, PMMY and other schemes targeting MSME.
The tenure of business loans is highly diverse according to the purpose: Working capital loans 1-3 years; equipment loans of the business 3-7 years; business growth loans 10 years; commercial real estate loans 15-20 years.
The standard business loans are usually required to have minimum business vintage of 2-3 years. Start ups can be covered under particular schemes under various criteria. Established, old businesses are usually offered superior terms and higher limits.
Secured business loans involve the use of collateral (property, equipment, inventory) and are normally offered at lower interest rates and greater loan value. Unsecured business loans do not need any form of security but carry a very high interest, have more eligibility requirements and a low limit of loans.
Majority of lenders ask a minimum credit score of 650-700 to loan businesses. Nonetheless, to get a good interest rate and to have a greater amount of loans, the score should be 750 and above. Certain MSME programs can be less restrictive in credit score requirements.
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