Differences Between Loans and Advances

Money is an essential part of any business. Without money, it would not be easy to run any business. Banks and financial institutes are the best way to raise funds for any business. Banks have many options for financing our business or project. Among them, Loans and Advances are the best options for business fund requirements which are very popular in the financing of the business.

What are Loans?

Finance is the blood of any business. It is the best and very popular financial facility provided by a bank or other financial institutes to help businesses at the time of money requirement. So, when it becomes difficult to arrange finance by the owner, the businesses can use this option to arrange funds for their business. This financing option is provided for the long term. Loans are a type of debt and have a repayment schedule for longer.

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What are Advances?

Advance is a credit facility provided by banks or financial institutes to cover daily fund requirements or as working capitalWorking CapitalWorking capital is the amount available to a company for day-to-day expenses. It’s a measure of a company’s liquidity, efficiency, and financial health, and it’s calculated using a simple formula: “current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)“read more. It is cheaper and more convenient to arrange short-term financeShort-term FinanceShort-term financing refers to financing a business for less than a year in order to generate cash for working and operating expenses, usually for a smaller amount. It include obtaining funds through online loans, credit lines, and invoice financing.read more as banks charge very low interest and charges on it. When businesses need money to cover their daily expenses such as salary, wages, or purchasing raw materials, they can think over this kind of credit facility from the banks.

Example of Loans and Advances

One company is looking for external funds for its business as it became so difficult for the business owner to arrange funds from his confidential sources. The business owner requires funds for two purposes,

  • As working capital (for daily expenses such as salary, wages, raw materials, etc.) andFor buying machinery for his business.

So, the business owner considers arranging funds from banks and other financial institutes. Let’s assume that the business owner approaches his bank with the firm’s current account.

Now the bank suggests two options to consider for funds, one is called loans, and the other is called advances which are credit facilityCredit FacilityCredit Facility is a pre-approved bank loan facility to businesses allowing them to borrow the capital amount as & when needed for their long-term/short-term requirements without having to re-apply for a loan each time. read more in nature.

  • Bank suggests choosing a loan option for buying machinery because it requires a huge amount, and business owners will be paying in a longer duration. This option is considered good when any business needs a huge amount for its business, and that amount can’t be repaid in a shorter duration, i.e., 6-12 months, and loans would be paid in equal monthly installments. Bank will charge interest on that, and some other charges would be included in the repayment schedule. The pre-closure option is also available if the owner wants to close the loan before tenure.But for daily expenses, the bank suggests choosing an advance credit option, a credit facility given by the bank to businesses where a business has to repay the outstanding amount in a shorter duration. So the Advanced credit facility is shorter, i.e., 1-2 months. It is a cyclic process, and once you repay the amount used as Advances, you can use the same amount for further requirements.A loan will be sanctioned and has to be repaid fully. When someone needs another loan for the same purpose, they must repay the full amount with interest within a predetermined period.But on the other side, money taken as advance has to be cleared in one transaction with some small bank charges.

Loans vs Advances Infographics

Let’s see the top differences between loans vs advances.

Key Differences

  • When businesses require huge money requirements for business expansion, such as machinery, plant, building, or any investment that requires huge money, the loan is the best option. It is not required to repay the loan amount in a shorter period. But when a business is looking to raise funds for covering expenses for a shorter period, such as salary, wages, purchasing raw materials, or other office expenses, the advanced option could be considered as once the business gets money from sales, debtors, or any other sources, advances can be cleared off.Loans can be given as a personal loan, home loan, or mortgage loan to businesses or individuals, but advances are specially designed for corporations for a particular purpose. Advance can be issued against debtors or future sales as well.Loans are sanctioned for a longer period. Most of the time, the repayment duration will be more than five years. But advances have to be cleared off within 1-2 months.Loans include the interest part with repayment. Interest is calculated on an annual basis, so if we take a long tenure for loan repayment, we have to pay more interest. Otherwise, other charges would be included with the repayment. Advance is a credit facility, and we can compare it with a credit card for better understanding. With the credit card, we can spend money, and repayment will be made every month, like advances also include some duration of clearing off.The loan is given once for a specified purpose and must be repaid fully before getting the second loan for the same purpose and on the same collateral. But advances are sanctioned as a Limit, and the amount can be used within that limit, and repaying and drawing of the amount would be permitted within that limit.There are so many legal formalities in the process of getting off a loan. As it carries a huge amount of money, banks will check the purpose of the loan and the repayment capacity of business firms. As per the repayment capacity and previous repayment records, the bank will sanction loans to businesses. We have to provide various financial or non-financial documents to the bank to convince them about the purpose and repayment capacity of the firms. But in the process of advance, it requires less documentation and legal formalities.Loans can be secured or unsecured. But most of the time, we have to put security as collateral for a loan if the loan amount is huge and the repayment tenure is also high. But for advances, we have to put security as collateral and a personal guaranteePersonal GuaranteeA personal guarantee is an agreement between three parties – lender, borrower, and guarantor, whereby the guarantor has legal binding attached to him to repay the lender and honour the loan agreement if the borrower defaults.read more of Directors. Banks also consider bills, receivables, stocks, etc., as security collateral.

Loans vs Advances Comparative Table

This has been a guide to Loans vs Advances. Here we discuss the top differences between loans and advances and an example, infographics and comparison table. You may also have a look at the following articles –

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