The process of using borrowed, leased or “joint venture” resources from someone else is called leverage. Using the leverage provided by someone else’s capital helps the user business go farther than it otherwise would. For instance, a company that puts up $1,000 and borrows an additional $4,000 is using 80% leverage. The objective is to increase total net income and the return on a company’s own equity capital.
· in payment terms, e.g. instalment versus single payment · in period-of-payment terms, e.g. short-term versus intermediate-term or long-term · in the manner of its security terms, e.g. secured versus unsecured · in interest payment terms, e.g. simple interest versus add-on, versus discount, versus balloon.
On the basis of the above classification, there are twelve common types of loans, namely: short-term loans, intermediate-term loans, long-term loans, unsecured loans, secured loans, instalment loans, single payment loans, simple-interest loans, add-on interest loans, discount or front-end loans, balloon loans and amortised loans.
Short-term loans are credit that is usually paid back in one year or less. Short term loans are usually used in financing the purchase of operating inputs, wages for hired labour, machinery and equipment, and/or family living expenses. Usually lenders expect short-term loans to be repaid after their purposes have been served, e.g. after the expected production output has been sold.
There are various ways of classifying loans, namely:
Loans for operating production inputs e.g. cotton for the Cotton Company of Zimbabwe (COTCO) and beef for the Cold Storage Company of Zimbabwe (CSC), are assumed to be self-liquidating. In other words, although the inputs are used up in the production, the added returns from their use will repay the money 100 percent approval installment loans borrowed to purchase the inputs, plus interest. Astute managers are also expected to have figured in a risk premium and a return to labour management. On the other hand, loans for investment capital items like machinery are not likely to be self-liquidating in the short term. Loans for family living expenses are not at all self-liquidating and must come out of net cash income after all cash obligations are paid.
Intermediate-term (IT) loans are credit extended for several years, usually one to five years. This type of credit is normally used for purchases of buildings, equipment and other production inputs that require longer than one year to generate sufficient returns to repay the loan.
Long-term loans are those loans for which repayment exceeds five to seven years and may extend to 40 years. This type of credit is usually extended on assets (such as land) which have a long productive life in the business. Some land improvement programmes like land levelling, reforestation, land clearing and drainage-way construction are usually financed with long-term credit.
Unsecured loans are credit given out by lenders on no other basis than a promise by the borrower to repay. The borrower does not have to put up collateral and the lender relies on credit reputation. Unsecured loans usually carry a higher interest rate than secured loans and may be difficult or impossible to arrange for businesses with a poor credit record.
Secured loans are those loans that involve a pledge of some or all of a business’s assets. The borrower may be able to bargain for better terms by putting up collateral, which is a way of backing one’s promise to repay.
The lender requires security as protection for its depositors against the risks involved in the use planned for the borrowed funds
Instalment loans are those loans in which the borrower or credit customer repays a set amount each period (week, month, year) until the borrowed amount is cleared. Instalment credit is similar to charge account credit, but usually involves a formal legal contract for a predetermined period with specific payments. With this plan, the borrower usually knows precisely how much will be paid and when.