1 00:00:05,950 --> 00:00:10,900 Now that you understand the definitions of the components of a business loan we'll move on to the types 2 00:00:10,900 --> 00:00:12,300 of business loans. 3 00:00:12,310 --> 00:00:14,630 This course focuses on business loans. 4 00:00:14,650 --> 00:00:19,180 I won't be covering personal loans even though many small business owners use personal loans like home 5 00:00:19,180 --> 00:00:24,880 equity lines of credit and I shudder to even think about it personal credit cards to provide funds for 6 00:00:24,880 --> 00:00:26,130 their business. 7 00:00:26,140 --> 00:00:30,550 The approval process for personal loans and how they are structured is very different from business 8 00:00:30,550 --> 00:00:36,430 loans so they aren't included in this course on the basics of business loans what types of loans to 9 00:00:36,430 --> 00:00:41,800 businesses get established businesses have a wide variety of loan and debt options. 10 00:00:41,800 --> 00:00:44,410 Small businesses have much less choices. 11 00:00:44,440 --> 00:00:48,710 In fact they use credit cards as much as they use other lines and loans. 12 00:00:48,850 --> 00:00:53,380 Owners use credit to know that credit cards including personal credit cards are a popular source of 13 00:00:53,380 --> 00:00:59,300 business financing they're an easy source of financing when someone is hungry for money to fund their 14 00:00:59,300 --> 00:01:00,390 business dream. 15 00:01:00,470 --> 00:01:05,150 When owners sign up for and use multiple cards it can seriously hurt their credit score though. 16 00:01:05,450 --> 00:01:10,280 If cash gets a little tight and they start missing payments even bigger damage is inflicted on their 17 00:01:10,280 --> 00:01:11,480 credit score. 18 00:01:11,480 --> 00:01:16,220 Ironically this could prevent them from getting other sources of capital to be more appropriate for 19 00:01:16,220 --> 00:01:17,450 their business. 20 00:01:17,480 --> 00:01:21,790 Credit cards have very high interest rates and fees especially when a payment is missed. 21 00:01:21,800 --> 00:01:26,570 This is easily the most expensive loan you can get another popular reason. 22 00:01:26,570 --> 00:01:30,710 Owners and employees like to use their personal credit cards for business expenses so they can earn 23 00:01:30,710 --> 00:01:32,240 miles or points. 24 00:01:32,240 --> 00:01:37,100 Business accounts payable or accounting departments have to balance an owner and employees desire for 25 00:01:37,100 --> 00:01:42,650 credit card rewards with using company cards that give the business more control reporting and efficiency. 26 00:01:42,770 --> 00:01:46,780 Business credit cards may be tougher to get them personal credit cards for new businesses. 27 00:01:47,030 --> 00:01:52,400 However business credit cards are a convenient way for companies to make purchases especially by multiple 28 00:01:52,400 --> 00:01:53,510 employees. 29 00:01:53,570 --> 00:01:58,310 It may be better to look to them more for their usefulness as a payment method than their appropriateness 30 00:01:58,400 --> 00:02:00,010 as a cash flow tool. 31 00:02:00,170 --> 00:02:06,050 Business lines of credit are an excellent business loan choice for short term cash flow needs you usually 32 00:02:06,050 --> 00:02:09,650 pay an annual commitment fee based on the commitment amount of the loan. 33 00:02:09,650 --> 00:02:14,330 For example if your commitment amount is one hundred thousand dollars and you are charged a 1 percent 34 00:02:14,330 --> 00:02:19,280 commitment fee you would owe 1000 dollars for the ability to use the line which may be advanced from 35 00:02:19,280 --> 00:02:20,120 the line. 36 00:02:20,180 --> 00:02:23,070 Interest is paid monthly based on the sum of the previous month. 37 00:02:23,090 --> 00:02:26,760 Daily principal times the daily interest rate. 38 00:02:26,810 --> 00:02:31,540 Lines of credit usually have a floating rate often with the prime rate as the index. 39 00:02:31,580 --> 00:02:34,590 It may be collateralized by inventory or receivables. 40 00:02:34,610 --> 00:02:39,320 Companies that are stronger financially can get unsecured lines because of their strength of the cash 41 00:02:39,320 --> 00:02:39,590 flow. 42 00:02:41,910 --> 00:02:46,650 I mentioned earlier that the commitment amount of the loan is the maximum amount you can have an outstanding 43 00:02:46,650 --> 00:02:48,990 principal at any time. 44 00:02:48,990 --> 00:02:53,540 The available balance is the commitment amount less any outstanding principal balance. 45 00:02:53,640 --> 00:02:57,360 When you borrow from the line it's called taking an advance or draw on the line. 46 00:02:57,360 --> 00:03:02,690 For example if you took an advance of 1000 dollars the principal balance of the line would go up 1000 47 00:03:02,850 --> 00:03:06,490 dollars and that would be credited to your deposit account at the bank. 48 00:03:06,510 --> 00:03:11,190 Operationally you do this as a transfer from the line to your deposit account via the bank's online 49 00:03:11,190 --> 00:03:12,560 banking system. 50 00:03:12,600 --> 00:03:16,450 The journal entry is a simple debit to cash and credit to loans payable. 51 00:03:16,530 --> 00:03:20,520 You make payments on the line by transferring money from your checking account to the line. 52 00:03:20,520 --> 00:03:24,610 It's very easy business lines are revolving lines of credit. 53 00:03:24,750 --> 00:03:28,020 You can take multiple advances and make multiple payments. 54 00:03:28,020 --> 00:03:33,210 Your commitment amount always stays the same but the available balance decreases with each advance and 55 00:03:33,210 --> 00:03:34,990 rises with each payment. 56 00:03:35,010 --> 00:03:37,750 Let's say your commitment amount is one hundred thousand dollars. 57 00:03:37,800 --> 00:03:40,950 That's also your available balance until you take an advance. 58 00:03:40,950 --> 00:03:46,280 If you take an advance of 1000 dollars your principal balance is 1000 dollars your available balance 59 00:03:46,280 --> 00:03:51,210 is ninety nine thousand dollars and your commitment amount is still one hundred thousand dollars. 60 00:03:51,240 --> 00:03:56,190 If you then make a payment of the 1000 dollars then your principal balance is zero and your available 61 00:03:56,190 --> 00:04:02,480 balance goes back up to one hundred thousand dollars one way lenders ensure that the line is used for 62 00:04:02,480 --> 00:04:08,270 short term needs is by requiring that you periodically rest the line resting the lines means paying 63 00:04:08,270 --> 00:04:10,340 the principal balance down to zero. 64 00:04:10,340 --> 00:04:14,660 How frequent you must do this and how long the principal balance must stay at zero before you can take 65 00:04:14,660 --> 00:04:16,940 advances again is detailed in your loan agreement 66 00:04:19,630 --> 00:04:25,020 lines of credit or for short term working capital needs like inventory payables or payroll. 67 00:04:25,030 --> 00:04:29,530 I know the head of a small company that received monthly financial statements always showed decent cash 68 00:04:29,530 --> 00:04:30,450 balances. 69 00:04:30,490 --> 00:04:33,580 He went to write a check in the middle of the month there was no cash. 70 00:04:33,610 --> 00:04:38,430 The bulk of his revenues were received near the end of the month his month and cash balances were fine. 71 00:04:38,440 --> 00:04:41,110 But he didn't realize how tight cash was mid-month. 72 00:04:41,110 --> 00:04:47,230 He got a line of credit to fix that lines are also used for longer seasonal needs. 73 00:04:47,290 --> 00:04:51,090 I mentioned earlier that I worked at a community bank that served many farmers. 74 00:04:51,220 --> 00:04:55,750 They would draw on their operating lines of credit during the growing season and pay the lines off after 75 00:04:55,750 --> 00:04:56,230 harvest 76 00:04:58,800 --> 00:05:00,610 lines are renewed annually. 77 00:05:00,630 --> 00:05:04,050 The lender will check on the financial health of the borrower during the renewal. 78 00:05:04,050 --> 00:05:08,640 The borrower will need to submit updated financial statements or tax returns to the bank. 79 00:05:08,640 --> 00:05:13,560 For those of you who provide tax audit or financial reporting services your clients will be asking for 80 00:05:13,560 --> 00:05:18,940 these reports to give to the bank one clause in loan agreements to look for that's common in lines of 81 00:05:18,940 --> 00:05:21,760 credit is the due upon demand clause. 82 00:05:21,760 --> 00:05:27,520 This clause allows the lender to call the loan at any time calling the loan means the lender can demand 83 00:05:27,520 --> 00:05:31,930 that the full outstanding balance needs to be immediately paid in full. 84 00:05:31,930 --> 00:05:35,950 This may happen if the borrower's financial situation is worsening. 85 00:05:35,950 --> 00:05:38,210 It may also occur when the lender is weak. 86 00:05:38,290 --> 00:05:43,600 It's used very very rarely but you want to be aware of it during times of extreme stress in the economy 87 00:05:43,600 --> 00:05:45,480 and the financial system. 88 00:05:45,640 --> 00:05:47,390 In the movie It's A Wonderful Life. 89 00:05:47,440 --> 00:05:51,660 George Bailey is about to leave on his honeymoon when Ernie the taxi driver points out that there's 90 00:05:51,670 --> 00:05:54,360 a run on the building and loan that Bailey runs. 91 00:05:54,400 --> 00:05:58,420 The panic was sparked when a bank the building alone worked with called their loan. 92 00:05:58,600 --> 00:06:02,920 The Building and Loan gave all the cash they had to the bank and closed their doors in panic. 93 00:06:02,920 --> 00:06:07,720 George calms the mob and saves the building alone until his uncle almost runs it again. 94 00:06:07,810 --> 00:06:08,910 A fun factoid. 95 00:06:09,000 --> 00:06:13,210 Bert and Ernie from Sesame Street were named for Bert the cop and Ernie the taxi driver I mentioned 96 00:06:13,210 --> 00:06:19,300 from that movie situations like that were more common during the Great Depression than during this most 97 00:06:19,300 --> 00:06:21,050 recent great recession. 98 00:06:21,070 --> 00:06:25,720 What did happen during the Great Recession was that banks reduced the commitment amounts of loans especially 99 00:06:25,720 --> 00:06:30,820 if the borrower never borrowed the maximum commitment amounts because that improved the bank's regulatory 100 00:06:30,820 --> 00:06:32,370 capital ratios. 101 00:06:32,380 --> 00:06:36,370 There's a joke that a banker is someone who's willing to lend you their umbrella when it's sunny but 102 00:06:36,370 --> 00:06:41,200 ask for it back when it starts to rain the dew upon demand clause and reduce commitment amounts are 103 00:06:41,200 --> 00:06:47,480 the realities behind the joke a term loan is a loan where principal and interest are paid on a schedule 104 00:06:47,480 --> 00:06:51,940 based on the term of the loan as opposed to lines where principal is drawn and paid back whenever the 105 00:06:51,950 --> 00:06:57,920 borrower wants equipment loans or term loans with amortization terms of 3 to 10 years and no balloon 106 00:06:57,920 --> 00:07:03,890 term equipment loans are usually fixed rate with consistent PMI payments they're collateralized by the 107 00:07:03,890 --> 00:07:10,970 equipment that's being purchased with the loan funds commercial real estate loans called CRT loans for 108 00:07:10,970 --> 00:07:13,350 short maybe fixed rate or variable rate. 109 00:07:13,460 --> 00:07:19,910 I explained earlier how they can have different repricing balloon and amortization terms they're collateralized 110 00:07:19,910 --> 00:07:24,750 by commercial real estate whereas equipment loans are usually extended when buying equipment. 111 00:07:24,890 --> 00:07:28,510 You can get a CRT loan when buying real estate improving real estate. 112 00:07:28,550 --> 00:07:32,730 We just want longer term loans and have equity in your commercial real estate to borrow from. 113 00:07:33,290 --> 00:07:37,640 It's common for businesses to have more than one loan collateralized by the same property. 114 00:07:37,670 --> 00:07:42,710 Another thing that can happen is for two pieces of property to be collateralized by the same loan. 115 00:07:42,710 --> 00:07:45,150 This is called Cross collateral ization. 116 00:07:45,230 --> 00:07:49,940 Selling one of those properties but not the other while paying off the loan will require approval of 117 00:07:49,940 --> 00:07:50,660 your lender. 118 00:07:52,760 --> 00:07:57,320 You may take out a construction loan if you're building or improving real estate construction loans 119 00:07:57,320 --> 00:07:59,170 have a term of 1 to two years. 120 00:07:59,240 --> 00:08:04,400 They're usually floating rate monthly draws or advances are made on the loan to pay the builder based 121 00:08:04,400 --> 00:08:09,570 on how much construction has been completed since the last payment at the end of the construction period. 122 00:08:09,590 --> 00:08:14,000 The construction loan is converted or refinanced into a commercial real estate loan discussed in the 123 00:08:14,000 --> 00:08:14,720 previous slide.