Sources of Business Finance Explained | Bank Loans, Trade Credit, Share Capital, Overdrafts & More #Finance

All businesses require Finance to survive initially and thrive over the long term, yet with such a wide variety of options to choose from selecting the most suitable

source of Finance can be a very confusing process. Businesses can acquire text-decoration: none;">Finance from either internal or external sources across both short and long term options. However choosing the best option for the business is crucial for its future Cash Flows whilst limiting the additional cost payable over the long term. This

CashNews.co explains the common sources of Finance available to businesses including the advantages and disadvantages of each. A bank Overdraft is the first

source of Finance we’re going to look at. In simple terms a bank Overdraft is when the business makes payments from their businesses current account

which exceeds the cash they actually have available. They are a very common way for small and medium-sized business enterprises to source Finance especially for businesses

that have Finance requirements which fluctuate on a regular basis. Typically the bank would offer an Overdraft to a business on either a rolling basis with

no set end date with interest added at regular intervals or over a fixed period of time. In addition to this Overdrafts can be pre agreed between the bank and the business in the form of an authorised Overdraft which typically has lower Interest

Rates in comparison to an unauthorised Overdraft, we will typically see the business charged additional fees on top of the interest, therefore if the business can foresee the requirement for additional funding it is better to arrange an authorised

Overdraft to keep the additional cost down. It is classed as a short-term external method of Finance as it should in theory be paid off soon after the

business receives it, this is due to the varying amounts of interest which can be added daily and ultimately it is repayable on demand by the bank. The actual amount of cash the business goes into the Overdraft will vary over time depending on the Cash Flows of the

business itself and if the size of the Overdraft increases to a significant amount the bank may require the business to secure the Overdraft against the Assets of the business. Importantly if it becomes a common occurrence for a business to be in

an Overdraft it may want to consider alternative options such as a bank Loan to reduce the additional amounts of interest and one-off charges incurred with an Overdraft. Some of the key advantages of a bank Overdraft include the

business only pays interest when it’s overdrawn and typically it is quick and easy to arrange and funds are available immediately after it’s been set up unlike other sources of none;">Finance there is typically no charge for clearing the balance earlier than expected. However, it is important to understand the disadvantages associated with bank Overdraft, firstly on the typical Overdraft Interest Rates vary,

therefore it is difficult for the business to accurately predict the cost of borrowing and not repaying the Overdraft can have serious consequences for the business as interest will keep adding to the total amount repayable. Also the business may lose Assets in the

process whilst directors of the company can also be personally liable dependent on the Overdraft agreement. Now we move on to bank Loans which are a very common source of business #1a73e8; text-decoration: none;">Finance when a business takes out a bank Loan it receives a set amount of money from the bank. However it’s important to note that the actual amount of money that a business can Loan from the bank and the amount

of time it has to repay the Loan depends on a number of factors. Let’s imagine you are a business and you require £10,000 to fund an upcoming project or expansion therefore you apply for a £10,000 bank Loan, the bank will receive your application and ask

questions and conduct numerous checks on the business and its owners they do this before deciding the maximum amount they are willing to lend and how long they’re willing to let the business have to repay this Debt. Bank Loans are commonly agreed and repaid

over a one to five year period but can be longer if both parties agree. Therefore it is classed as a medium to long term external source of Finance and the interest on the

bank Loan can be set at a fixed rate at the time of the Loan agreement such as 7.9 percent APR and this will be the set amount of interest that is charged until the Loan has been repaid. Alternatively the business may choose to have interest

charged on a variable basis meaning that the amount of interest charged on the amount borrowed will vary over time according to any changes in the market when things are going economically well in terms of growth and Inflation, Interest Rates are likely to increase

to discourage spending and influence people see Savings as a more attractive option and borrowing as a more costly one. Whereas in economic downturns such as a recession Interest Rates are often cut to encourage spending therefore a variable rate can see the

business pay much less in interest over the terms of Loan yet this is a risk if during the Loan there is an economic upturn and Interest Rates keep rising, so will the amounts of interest that business pays on their Loan. The key

advantage of a bank Loan is that both the business and the bank enter the Loan agreement knowing the exact amount borrowed the interest charge and the repayment schedule, this provides both the business and the bank with more accurate information for their

Cash Flow planning whilst providing the business with a guaranteed source of Finance. Also there are no additional charges as long as the business adheres to

the Loan agreement. The cost of Finance such as interest and additional charges are typically lower than many other sources of business

href="https://cashnews.co/finance" style="font-weight: bold; color: #1a73e8; text-decoration: none;">Finance, if the business is taking a Loan to purchase an asset such as a car or machinery it can match the length of this Loan to match the estimated

lifetime of their asset meaning that they can renew their Loan and purchase the new asset at this point. However there are a number of drawbacks to bank Loans which businesses must consider when applying. One of the most important drawbacks is the bank’s

legal right as a secured Creditor with collateral over the business’s Assets if the business gets into financial difficulty and fails to repay the Loan the bank has the legal right to acquire the business’s Assets

before the shareholders. Also, dependent on the type of business the owner’s personal Assets may be at risk. If the business wants to repay the Loan early they may also be charged with an early repayment fee and they also need to pay interest on the money

that they’re never actually used. For example let’s imagine a business takes out a £10,000 Loan over a five year period for an expansion project and a year into this expansion project they realise that the only actually require £6,000, they will still be charged

interest on the additional £4,000 part of borrowing. The same business then decides that they want to repay the £10,000 Loan in full after three years. They may also then incur additional charges for not adhering to the full term agreement even though it has been paid back in

full and early. A final key disadvantage is the time it takes to a range of business Loan agreement and the fact that the bank is under no obligation whatsoever to Loan any money to any business. This is a real disadvantage for small businesses and startups that

the banks may deem them to be a greater risk due to their smaller Cash Flows, lack of valuable Assets for security or simple a limited history of the business. We now move on to owners Capital there are a few businesses that start without some form

of financial input from the owner this comes in many forms and isn’t always a cash injection. Typically an entrepreneur will save up money or sell personal Assets to fund a business start this is a low-risk option for the entrepreneur given the fact that all they have to lose

is the money that they actually invested into the business if this was the sole form of Finance for the business then they owe no money at all to any other stakeholders or

shareholders which is a great financial strength for any business. Having said that if the business owner did want to source more Finance for the business it also shows

potential investors or the banks that the owner is committed and believes in the business. It’s important to be aware at this point the personal funding is not just for business startups and many business owners invest their own personal money into their business at various times over its

lifetime. Therefore it is seen as a long-term internal source of Finance. We now move on to trade Credit which in its simplest form is when a business has an

account set up with their supplier, this account allows a business to purchase and receive goods or services without having to pay at the point of sale. It is a short-term external source of none;">Finance and is an essential element of many businesses Cash Flows essential allowing them to make a Profit before paying for the goods in the best case scenario. Imagine you own a small convenience store and you purchase a hundred chocolate bars

on your account through trade Credit at your local wholesalers for £50, so each chocolate bar cost you 50p, the terms on your Credit account allow you 30 days before you have to pay the balance in full. Now you’re a busy convenience store and chocolate bars

are popular so you put these on sale for £1 pound each and they all sell within 10 days. This is great it means you’ve made a Profit of £50 and you still have 20 days before you have to pay the balance this puts you in a great position as you can even reinvest these

Profits further and buy more chocolate bars or you can just pay off your trade account with the money that you’ve made this is a great scenario for the business. However it’s worth noting that not every trade Credit transaction is as simple as this and

it’s important that the business has sufficient funds to pay the account in full by the agreed date should they fail to generate any Revenue from the original purchase of supplies, otherwise this could lead to a breakdown in relationship with the supplier and bad

word-of-mouth for the business. Trade Credit has a key advantage is very easy to organise between the business and the supplier, it is also widely available across many none;">Industries and it is typically a low-cost source of Finance as there is usually no additional fees. However some key drawbacks include the possible breakdown

between the business and supplier should one not stick to the agreed terms especially if the business fails to pay on time they may lose a critical supplier . In contrast to this there may be a demand from the business’s own customers who want the facility of trade Credit

which will then impact the business’s Cash Flow negatively. Whilst it may increase the footfall of customers, they may then not pay on time causing Additional time and money to chase the payment or even force the business to use a Debt factoring service.

Moving on to retained Profits which is one of the most crucial sources of Finance for many businesses, the concept of retained Profits is

truly the heart of business growth, essentially a business makes a net Profit and then simply reinvest its Profit back into the business rather than receiving it personally or making a payment to shareholders. Retained Profits are seen as a

long-term internal source of Finance providing the owners with complete freedom on how they reinvest it back into the business. They could spend it on expanding the range of

stock to attract more customers, it could be spent on machinery or tools to increase efficiency or it could just be left in the bank account for a rainy day. Some key advantages of using retained Profits as a source of

style="font-weight: bold; color: #1a73e8; text-decoration: none;">Finance include the fact that the owners of the business have complete control over how this is spent in the business importantly by retaining these Profits the business does not have to repay this money

back to any person or bank in the future and doesn’t have the additional charges such as interest which is added in many of other sources of Finance. However there are

a number of drawbacks to this source of Finance, firstly the business owner should be aware of potential disagreements in how the Profit should be shared or

retained which may upset shareholders if they believe they should have received more of this retained Profit personal in the form of Dividends. Also the business cannot rely on retained Profits as a consistent form as

href="https://cashnews.co/finance" style="font-weight: bold; color: #1a73e8; text-decoration: none;">Finance as they are not guaranteed to make a Profit year on year. It’s also very important for business owners to consider the impact of retaining

Profits every year as this can make the business look less attractive to potential investors in the future. Moving on to share Capital, so share Capital is when a business looks to source

style="font-weight: bold; color: #1a73e8; text-decoration: none;">Finance by selling Shares in the business to investors, it is seen as a long-term source of none;">Finance within which an investor will receive a percentage share in the business in return for a monetary amount which is agreed between them and the business, the investor then becomes a shareholder and is protected by a limited liability and will see return on their investment

in the form of dividend payments or the Profit made if they decide to sell their share in the future. Share Capital has a number of advantages for a business including the fact that the business is not required to repay anything for this source of

href="https://cashnews.co/finance" style="font-weight: bold; color: #1a73e8; text-decoration: none;">Finance and no interest is charged which is a huge positive in comparison to alternative sources of #1a73e8; text-decoration: none;">Finance such as a Loan or an Overdraft however every time the owner agrees to sell more Shares in the business to raise money they are reducing the Shares that they personally own and

ultimately the control they have in the business. Another positive of share Capital is that the business has full control of how many Shares they want to sell how, much they want to sell the share for and who they actually sell the Shares to if it

is a private limited company but a public limited company unfortunately doesn’t have this luxury. Also because shareholders Profit from the business’s success over the long term not only does this raise additional

style="font-weight: bold; color: #1a73e8; text-decoration: none;">Finance but the investor would actually want the business to succeed in the future and can support the business with their additional skills and experience. A final consideration for a business owner is that shareholders

also share the Profits of the business according to their share in the business reducing the amount of Profit the initial owner takes. We are now going to look at venture Capital which is regarded as a long-term external source of

href="https://cashnews.co/finance" style="font-weight: bold; color: #1a73e8; text-decoration: none;">Finance within which an investor known as a venture Capitalists would invest their own money into a business in exchange for an agreed share in the business’s

Equity. Venture Capital is commonly used when there is an element of risk and a high potential for business growth within which investors invest their money into the business startup or one that is looking to expand. Typically a venture Capitalist

would look to invest in businesses with high growth potential within the next five years and would usually look to sell and cash in on their share of the business within ten years of investing. Venture Capitalists come in the form of individuals but more commonly in the form of

venture Capital firms or business angels The key advantage is that it is widely available for businesses which are deemed to be more risky within which over forms of none;">Finance such as a Loan or a grant may not be available. However due to risky nature of venture Capital Finance the

business owner would typically have to exchange a high proportion of Equity in order to secure the funding, also many businesses who were applying for venture Capital get rejected after the initial review of their business plan and even if they do get past this

initial stage the typical process takes around three to six months to secure funding which is a much longer time scale than many other sources of Finance. And the final

source of Finance were going to look at today is crowdfunding which is an alternative source of business bold; color: #1a73e8; text-decoration: none;">Finance commonly used by business startups instead of venture Capital. Crowdfunding relies on multiple contributions from a wide range of people via internet platforms with each platform having slightly different processes

but ultimately the entrepreneur will pitch their business as a project suggesting why they want to start the business what its purposes is and how much funding they need to get it started. It is classed as a long term external source of

style="font-weight: bold; color: #1a73e8; text-decoration: none;">Finance and as an incentive to contribute, the contributors are typically offered rewards dependent on the amount they contribute, the higher the contribution, the more lucrative the reward. There are many advantages of

crowdfunding especially how simple, accessible and quick it is to set up and reach an audience of potential contributors. Following this the business owner still retains full control of business while creating a community of loyal fans before the business has even started, this community of

contributors will typically have a vested interest in the business and would usually be willing to listen to the business’s ideas and provide feedback along the way within which early contributors may identify weaknesses in the brand or its products and suggest improvements before it goes to

mass market. However it’s important to consider some of the potential drawbacks before pursuing crowdfunding, none more so than the fact that the business may not receive any contributions at all no matter how good the idea is due to the intense competition in the crowdfunding arena because

of it’s clear advantages to the businesses who receive contribution. Another key consideration is the risk of your idea been stolen once it is in a crowdfunding platform as it’s available for the general public to see and potentially copy with many examples of this happening today such

as Pressy which raised $600,000 through crowdfunding but the idea was copied, manufactured and launched before Pressy was even shipped. Well I hope this has been a helpful introduction to the different sources of #1a73e8; text-decoration: none;">Finance available to businesses, if it has remember to give the CashNews.co a thumbs up and subscribe for lots more business studies CashNews.cos. There is also an activity worksheet in the description of this CashNews.co if you would like to test your

knowledge further. Thanks for listening and all the best