• You may require funds for a new project, enhancing the existing project, and manage the working capital.
• You should ensure repayment availability before raising debt because if you fail to do so, your security asset will be lost.
• For calculating the amount of loan, you should evaluate project cost, project cash flows, and check the profitability of the project.
• There are many benefits of a loan such as ownership retention and tax-deductible interest.
How to determine the Loan Amount
1: Why do you need funds?
It’s important to analyse why you need funds before taking a loan.
The possible reasons to require funds are:
• New project or enhancing existing project
• Manage working capital while you await your payment from buyers for the following reasons:
- Supplier’s payments
- Bank loan
- Salaries
- Interest
- Electricity bill
- Rent
- To repay loan
2: Points to remember before raising funds
• You will only borrow a debt when you can bear interests on a monthly basis because you not only borrow a debt but a fixed liability to pay monthly interest at any cost.
For example:
• If your debt amount is Rs. 1000 with an interest rate of 10% per annum.
• It means you’ll have to give Rs. 100 as interest every year.
• You should ensure repayment availability before raising debt because if you fail to do so, your security asset (land, jewellery, vehicle, machine, factory, stock, etc) will be lost.
• You should raise debt only when you have something as collateral or something you can give as a bargain such as land, shop, building, warehouse, factory, house, etc. because the bank doesn’t prefer giving unsecured loans.
• If you’re taking a loan for working capital, then your stock (raw or finished goods) can be your collateral.
• You must have a surety of cash flows before raising a debt, otherwise, uncertainty of cash flows can lead to not repaying loans or interests.
• You should ensure that your project is profitable because of rising debt.
• If your revenue is higher than your cost/investment, only then you’ll have a profitable project.
For example:
• You must have heard that companies like Swiggy, Zomato, Uber, Ola cabs, OYO rooms, are loss-making companies.
• They sell their equities but do not get loans from the banks or markets.
3: Calculation of loan amount
To calculate the amount of loan, you need to:
• Evaluate project cost
If you figure out that you need Rs. 100 as an investment, then you should determine which section of money will go into personal capital and bank loan payment.
For example:
• If you have to buy a house of Rs. 1 crore, then you must know that 20% of it, i.e. Rs. 20,00,000 should be your down payment.
• The rest of the money, i.e. Rs. 80 lakhs can be taken as a loan from the bank.
The bank will give you the amount on the following two bases:
• Property value: Before giving you a loan of Rs. 80 lakhs, the bank will first check if the property is enough for them to retain the cost in case of non-payment of the loan.
• Income: They will check the EMI of your loan amount will be for a specific number of periods.
For example:
• On a loan amount of Rs. 80 lakhs, the EMI of 20 years will be Rs. 900 per month, i.e., Rs. 72,000 per month.
• To ensure that you’ll be able to pay the instalments, they’ll check your balance sheets and salary slips.
• Project cash flows
• You have to project that the factory or machine you’re setting up, or the new project you’re starting has a good cash flow.
• Check profitability
• If your profitability is enough to pay interest, then the bank will give you loans easily.
• Check eligibility
• After you’ve checked all the points, you can now check if you’re eligible to get a loan and the amount that can be raised through a loan.
4: Benefits of loans
• Ownership retention (You don’t have to pay equity, shareholding, partnership, or board seat to the bank.)
• Tax-deductible interest
People sometimes feel that taking a loan is a risk, but that happens only when you have uncertain cash flow projections and less profitability.
Conclusion:
• Check your eligibility before raising debts
• Evaluate your project cost & its profitability before raising a loan