The Role of commercial banks as source of debt capital for small businesses

Commercial banks are the biggest source of debt capital for small businesses, providing them the greatest number and variety of loans. Commercial banks often lend short-term loans which may include commercial loans, lines of credit, or floor planning. Although they sometimes lend intermediate and long-term loans which may include term loans, installment loans, discounted installment contracts, or character loans.

According to small business administration commercial banks provide %64.7 of all traditional debt to small businesses, %86 of which less than $100,000. However banks are conservative in their practices and prefer to make loans to established small businesses rather than to high-risk start-ups.

The most common type of loans banks make to small companies are the short-term loans which are extended for less than one year. Commercial loans are unsecured short-term loans (three to six months) that expect the owner to repay the total amount at maturity. Lines of credit are the most common type of short-term loans which provide short-term cash flow for day-to-day operations. Floor planning is a form of financing frequently used by retailers of ‘big ticket items”. In this form of financing suppliers loan the big ticket items in a form of consignment with a set interest rate and collect the money after the items are purchased by consumers.

Banks make intermediate and long-term loans in certain cases. These loans are extended for one year or longer. These loans are usually made for the purpose of starting a business, constructing a plant, purchasing real estate and equipment, or other long term investment. Term loans, installment loans, discounted installment contracts, and character loans are the common types of intermediate and long-term loans.  

Commercial banks constantly change their policies and requirements due to changes in economy, risk assessment, government regulations, opportunity costs, and budget; yet they remain the major source of debt capital for small businesses. It is recommended that entrepreneurs maintain a positive relationship with their bankers and put together presentable portfolio, financial statements, and business plan prior to applying for loans.  

Resource:

Scarborough M. Norman, Wilson L. Douglas, Zimmerer W. Thomas; Effective Small Business Management, Pearson Prentice Hall, Upper Saddle River New Jersey: 9^th Edition.