Sources of Finance: Bank Overdrafts and Bank Loans

What is long term finance?

Finances the whole business over many years

What are examples of long term finance?

• Share capital

• Retained profits

• Venture capital

• Mortgages

• Long-term bank loans

What is medium term finance?

Finances major projects or assets with a long life

What are examples of medium term finance?

• Bank loans

• Leasing

• Hire purchase

• Government grants

What is short term finance?

Finances day-to-day trading of the business

What are examples of short term finance?

• Bank Overdraft

• Trade creditors

• Factoring

What are internal sources of finance?

• Retained profits

• Working capital

• Asset disposals

What are external sources of finance?

• Share capital

• Bank loan/overdraft

• Debentures

• Venture capital

• Suppliers

What are key features of bank loans?

• The loan is provided over a fixed period (e.g. 5 years)

• The rate of interest either fixed or variable

• Timing and amount of repayments are set

• Usually, some security is required for the loan

What are the benefits of bank loan?

• Greater certainty of funding provided terms of the loan complied with

• Lower interest rate than a bank overdraft

• Appropriate method of financing fixed assets

What are drawbacks of bank loans?

• Requires security (collateral)

• Interest paid on the full amount outstanding

• Harder to arrange

• Startups and small businesses are often excluded

What are key features of bank overdrafts?

• Short-term finance, widely used by businesses of all sizes

• An overdraft is really a short-term facility- the bank lets the business ‘owe it money’ when the bank balance goes below zero

• A flexible source of finance: only used when needed

• Excellent for helping a business handle seasonal fluctuations in cash flow or when the business runs into short-term cash flow problems (e.g. a major customer fails to pay on time)

What are benefits of bank overdrafts?

• Relatively easy to arrange

• Flexible- use as cash flow requires

• Interest- only paid on the amount borrowed under the facility

What are the drawbacks of bank overdrafts?

• Can be withdrawn at short notice

• Interest charge varies with changes in interest rate

• Higher interest rate than a bank loan