Overdrafts: A flexible arrangement where a bank allows a business to spend more money than is in its account up to a certain limit. It is ideal for managing temporary cash flow gaps but often carries high daily interest rates.
Trade Credit: This allows a business to obtain goods or services from suppliers and pay for them at a later date, typically 30 to 90 days. It effectively provides interest-free finance for inventory, though missing deadlines can damage supplier relationships.
Bank Loans and Mortgages: A fixed sum of money borrowed for a set period and repaid with interest in regular installments. Mortgages are specifically used for purchasing property and are secured against the asset itself.
Share Capital: Limited companies can raise significant funds by selling shares (ownership portions) to investors. While this does not require repayment or interest, it dilutes the original owners' control and requires sharing future profits.
Crowdfunding: This involves raising small amounts of money from a large number of people, typically via online platforms. It is often used by startups to validate a product idea while securing initial funding.
Leasing and Hire Purchase: These methods allow a business to use assets (like vehicles or machinery) by making regular payments. In leasing, the business never owns the asset, whereas in hire purchase, ownership transfers after the final payment.
| Feature | Debt Finance (e.g., Loans) | Equity Finance (e.g., Shares) |
|---|---|---|
| Repayment | Must be repaid with interest | No repayment required |
| Ownership | No loss of control | Ownership is diluted |
| Cost | Interest is a fixed expense | Dividends are paid from profits |
| Risk | High risk if unable to meet payments | Lower risk as no fixed repayments |
Matching Source to Use: Always ensure the duration of the finance matches the life of the asset. For example, use a long-term loan for a building, but an overdraft for monthly utility bills.
Evaluate the Trade-offs: When asked to recommend a source, consider the cost (interest rates), control (voting rights), and risk (collateral requirements).
Check the Business Type: Remember that only limited companies (Ltd or Plc) can issue shares. Sole traders and partnerships must rely on other sources like personal savings or bank loans.
Analyze Financial Health: A business with high existing debt (gearing) may find it difficult or expensive to secure further loans, making internal sources or share capital more attractive.
