Money is an essential element for any business because it fulfills the short-term and long-term requirements of funds. It is not possible for the owner to bring all the money himself, so he/she take recourse to loans and advances. Loans refer to a debt provided by a financial institution for a particular period while Advances are the funds provided by the banks to the business to fulfill working capital requirement which is to be payable within one year.
|BASIS FOR COMPARISON||LOANS||ADVANCES|
|Meaning||Funds borrowed by an entity from another entity, repayable after a specific period carrying interest rate is known as Loans.||Funds provided by the bank to an entity for a specific purpose, to be repayable after a short duration is known as Advances.|
|What is it?||Debt||Credit Facility|
|Term||Long Term||Short Term|
|Security||May or may not be secured||Primary security, collateral security and guarantees.|
Definition of Loans
The amount lent by the lender to the borrower for a specific purpose like the construction of the building, capital requirements, purchase of machinery and so on, for a particular period of time is known as Loan. In general, loans are granted by the banks and financial institutions. It is an obligation which needs to be repaid back after the expiry of the stipulated period.
The loan carries an interest rate on the debt advanced. Before advancing loans, the lending institution checks the credit report of the customer, to know about his credibility, financial position and capacity to pay. Loan is classified in the following categories:
- On the basis of Security:
- Secured Loan: The loan which is backed by securities is Secured Loan.
- Unsecured Loan: The loan on which no asset is pledged as security is Unsecured Loan.
- On the basis of Repayment:
- Demand Loan: The loan which is repaid on demand of the lender is Demand Loan.
- Time Loan: Loan, which is repaid in full at a future specified date is Time Loan.
- Instalment Loan: Loans which are to be repaid in evenly distributed monthly instalments is Installment Loan.
- On the basis of Purpose:
- Home Loan
- Car Loan
- Education Loan
- Commercial Loan
- Industrial Loan
Definition of Advances
Advances are the source of finance, which is provided by the banks to the companies to meet the short-term financial requirement. It is a credit facility which should be repaid within one year as per the terms, conditions and norms issued by Reserve Bank of India for lending and also by the schemes of the concerned bank. They are granted against securities which are as under:
- Primary Security: Hypothecation of Debtors, Stock Pro-notes, etc.
- Collateral Security: Mortgage of land and buildings, machinery, etc.
- Guarantees: Guarantees given by partners, directors or promoters, etc.
The following are the forms of bank advances:
- Short term loans: Advance in which the entire amount is provided to the borrower at one time.
- Overdraft: A facility provided by the bank in which the customer can overdraw money from his account up to a specified limit.
- Cash Credit: A facility granted by the bank in which the customer can advance money up to a certain limit against the asset pledged.
- Bills Purchased: An advance facility provided by the bank against the security of bills.
Now, from the above discussion, it is clear that loans and advances are two different terms. Loans are the source of long-term finance while the Advances are granted by the banks to meet short-term financial requirements i.e. they are repayable within one year. Interest is charged on both as well as both are repayable either in a lump sum or instalment or on demand.