Sources of Finance: Bank Overdrafts and Bank Loans

Long-term:

• Finances the whole business over many years

  • Share capital

  • Retained profits

  • Venture capital

  • Mortgages

  • Long-term bank loans

Medium-term:

• Finances major projects or assets with a long life:

  • Bank loans

  • Leasing

  • Hire purchase

  • Government grants

Short-term:

• Finances day-to-day trading of the business

  • Bank Overdraft

  • Trade creditors

  • Factoring

Internal Sources:

• Retained profits

• Working capital

• Asset disposals

External Sources:

• Share capital

• Bank loan/overdraft

• Debentures

• Venture capital

• Suppliers

Bank loans: Key Features:

• 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

Bank Loan benefits:

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

• Lower interest rate than a bank overdraft

• Appropriate method of financing fixed assets

Bank Loan drawbacks:

• Requires security (collateral)

• Interest paid on the full amount outstanding

• Harder to arrange

• Startups and small businesses are often excluded

Bank Overdrafts- key features:

• 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)

Bank Overdraft benefit:

• Relatively easy to arrange

• Flexible- use as cash flow requires

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

Bank Overdraft drawbacks:

• Can be withdrawn at short notice

• Interest charge varies with changes in interest rate

• Higher interest rate than a bank loan