Introduction to Loan Capital
Loan capital is that part of your business finance which is made by way of loans, it is usually secured on business assets and sometimes personal assets of the owner.
The loan capital is provided by a lender and your business is called the borrower. The loan will be subject to lending criteria which need to be satisfied before the loan is made.
Loan capital is normally evidenced by a note or document which specifies the amount, interest rate, and date of repayment. Failure to make repayments on loans can result in penalties or ultimately winding up proceedings against the business.
Short term Loan Capital
Short term loans are repayable in less than one year and are included as part of current liabilities in the balance sheet. They include short term bank loans and overdrafts.
Long term Loan Capital
Long term loans are repayable in more than one year and are included as part of long term liabilities in the balance sheet.
Long term capital normally falls within one of two categories, bank loans or mortgages which are long term loans used to purchase property.
Market Interest Rate
The interest rate is the rate at which interest is paid by a borrower for the use of a lenders money, it is the cost of obtaining money.
The market interest rate is simply the interest rate existing at a particular time as determined by the supply and demand of money in the money market.
Like any commodity, if demand exceeds supply the price will increase, and likewise if supply exceeds demand the price will fall.
In this case the commodity is money, and the price is the market interest rate. As the demand for money exceeds supply the market interest rate rises, as the supply of money exceeds demand the market interest rate falls.
The supply and demand for money, and therefore the money market interest rate, can be affected by many factors including, inflationary expectations, risk, availability of alternative investments, economic and political considerations, taxes and liquidity.
Types of Loan Capital
There are different types of business loans available including:
Fixed rate loans have a fixed interest rate throughout the term of the loan.
The advantage of a fixed rate loan are that it allows a business to plan its future debt repayments as these do not vary over time, and it safeguards the business against any increases in interest rates over the term.
The disadvantage of a fixed rate loan is that in the event that interest rates fall, the business is left with the higher fixed interest rate until the end of the term unless is pays a penalty to terminate the loan agreement.
Fixed installment loans have fixed amount scheduled repayments made throughout the term of the loan.
Secured loans as the name implies are secured on the assets of the business and on occasions on the personal assets of the owner. A mortgage is a particular type of secured loan which is used to purchase property. To secure the mortgage loan, the interest is transferred from the borrower (mortgager) to the lender (mortgagee). In the event that the loan is not repaid, the lender may foreclose and take the property.
Variable rate loan capital has an interest rate which changes throughout the term of the loan and is usually set in relation to an underlying bank rate such as Base rate or LIBOR.
Unsecured loans do not require any security and includes such items as credit cards and occasionally bank overdrafts.
Convertible loans are loans which can be changed from one type to another during the term of the loan.
How do you Record Loan Capital?
Loans are recorded in the General Ledger.
If for example, a business obtains a loan from a lender of 10,000, and the amount is paid into the business current account at the bank, the journal entry would be.
|Bank Current Account||10,000|
This reflects the cash being received into the bank account, and the liability of the business to the lender.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.