question archive Khabib McGregory, a small business customer approaches your bank for finance to purchase some hi-tech equipment for his manufacturing unit
Khabib McGregory, a small business customer approaches your bank for finance to purchase some hi-tech equipment for his manufacturing unit
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Khabib McGregory, a small business customer approaches your bank for finance to purchase some hi-tech equipment for his manufacturing unit. Would you rather give him a term loan or an overdraft? Evaluate this option you have chosen. Explain five main differences between loans and overdraft facilities, and use these to explain your answer.
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For any manufacturing unit, for purchase of an equipment, only term loan is given and not an overdraft. Hence, in this case we will give him a term loan for purchasing the equipment.
The main differences between loans and overdrafts is tabulated below:
| Loan | overdraft |
| It is a fixed amount borrowed from a bank for a fixed period and fixed repayment schedule. In this case, we will fix the terms of repayment based on expected additional income generated after using the new equipment | In case of overdraft, a limit is sanctioned in a current account and the borrower can withdraw from the account as per his requirements within the overall limit |
| The interest is calculated on monthly outstanding basis and is taken into consideration while fixing repayment schedule | The interest is chaged on daily outstanding i.e the overdraft amount borrowed |
| Loans are given for long term say for 3 to 10 years depending on the useful life of the equipment/ machinary. In this case, we will give for a term commensurate with the useful life of the equipment | Overdraft is for a short term and used for financing day to day requirements of a business. |
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Loan is to be piad within a definite time period through monthly/ quarterly instalments. No fresh borrowing is allowed in a loan account. |
Overdraft can be closed any time by depositing the outstanding balance in lump sum. Overdraft amount can be increased or decreased depending on the requirement of the borrower |
| Loan can be given to a person who may not have a current account with the bank. | The borrower should have a current account with the bank in which an overdraft limit is sanctioned. |
