Financing Your Business

3. Bank Finance

After your own family, the most likely source of borrowing is the bank.

3.1 Many businesses need overdraft finance from time to time. Overdrafts are useful for financing temporary - or fluctuating - cash shortages.

• You pay interest only on the amount you are overdrawn each day.
• Exceeding your overdraft limit is costly. The bank may return payments, damaging your credit with suppliers. You can also incur material bank charges and higher interest rates.
• The bank could, in principle, demand repayment in full at any time, usually at 24 hours' notice.
• Your overdraft limit is usually agreed for six to 12 months, after which it must be extended by negotiation. However, the limit can be reduced if the bank decides this is necessary.

3.2 Loan finance is often the best way to finance a longer-term business need.

• Most loans are for a fixed period of one to ten years. Mortgages and some other loans may be for as long as 25 years.
• Repayments are agreed in advance. Paying equal monthly instalments of capital plus interest is a common choice. You may be able to arrange a repayment holiday to allow time for your cashflow to pick up before the first repayment is due.
• Loans are more suitable than overdrafts for longer-term finance. Both you and the bank make a commitment to the business, based on an understanding of your long-term plans and forecast cashflow. Your bank can advise you on what information is required and how figures should be presented when seeking a loan.

3.3 Bank-finance costs can vary widely.

• The interest rate for both overdrafts and loans is usually set at a margin over the bank base rate, which can vary. Margins on loans are usually 2 to 6 per cent, depending on how risky the bank thinks the loan is. Alternatively, the interest rate may be fixed (eg a flat-rate ten per cent).
• An arrangement fee is usually levied when an overdraft facility or loan is set up. Typically the fee is one to 1.25 per cent of the facility requested.
• A renewal fee is sometimes charged when an overdraft facility is extended.
• You may incur costs arranging security (see 5).