THE SOURCES OF

FINANCE-IN DEPTH
BANK FINANCE
SHORT-TERM FINANCE
WORKING CAPITAL FUNDING
MEDIUM-TERM FINANCE
LONG-TERM FINANCE
BANK FINANCE
• also known as BANK LOAN or BANK ADVANCE the advance of a specified sum of money to an individual or
business (the borrower) by a COMMERCIAL BANK, SAVINGS BANK etc. (the lender).
• is a form of CREDIT which is extended for a specified period of time, usually on fixed-
interest terms related to the base rate of
interest, with the principal being repaid either on a regular installment basis or in full on the appointed redemption
date. Depending upon the nature of the loan and the degree of risk involved
• a bank loan may be unsecured or
secured, the latter requiring the borrower to deposit with the bank an approved form of COLLATERAL SECURITY
(for example the property deeds to his house).
• in the case of businesses, bank loans are usually renegotiated shortly
before expiring, thus providing the borrower with a ‘revolving’ line of credit used mainly to finance WORKING
CAPITAL requirements.
Types of Bank Finance (Bank Loan)

 Short-term Finance
• Overdrafts- are used in conjunction with business bank accounts and are a flexible source of working capital for
short-term needs.
• Bridging finance- is provided by the bank to businesses to maintain cash flow while awaiting funds from grant
cheques, drawdown of commercial mortgages or loan agreements, or other confirmed sources of future income.
 Working Capital Funding
• Invoice finance- offers ways to access working capital by unlocking the value of invoices, although interest rates
and charges apply on the cash advanced.
• Invoice discounting- allows you to draw on funding secured against approved invoices.
 Medium-term finance
• Term loans- have a fixed or variable interest rate and mature over a one- to seven-year period. They are typically
used to buy fixed assets such as property or machinery or other purchases of a capital nature.
• Asset finance and leasing- options allow businesses to spread the ownership associated with buying assets.
When you buy assets through leasing finance, the leasing bank buys the equipment for you to use, in exchange
for regular payments. Leasing or hire purchase can help you maintain cash flow and allow greater flexibility in
upgrading equipment.
 Long-term finance
• Commercial mortgages- are provided by banks to finance the purchase of business premises.
• Fixed asset loans- are loans for assets that cannot easily be turned into cash - e.g. property, plant or machinery.
The loans can be fixed for up to ten years. With this type of loan, the asset itself is the collateral and can be
repossessed if you do not maintain repayments.
Advantages and Disadvantages of Bank Finance
Advantages:
 The loan is not repayable on demand and so available for the term of the loan - generally three to ten years -
unless you breach the loan conditions.
 Loans can be tied to the lifetime of the equipment or other assets you're borrowing the money to pay for.
 At the beginning of the term of the loan you may be able to negotiate a repayment holiday, meaning that you
only pay interest for a certain amount of time while repayments on the capital are frozen.
 While you must pay interest on your loan, you do not have to give the lender a percentage of your profits or a
share in your company.
 Interest rates may be fixed for the term so you will know the level of repayments throughout the life of the loan.
 There may be an arrangement fee that is paid at the start of the loan but not throughout its life. If it is an on-
demand loan, an annual renewal fee may be payable.
Disadvantages:
 Larger loans will have certain terms and conditions or covenants that you must adhere to, such as the provision
of quarterly management information.
 Loans are not very flexible - you could be paying interest on funds you're not using.
 You could have trouble making monthly repayments if your customers don't pay you promptly, causing cash flow
problems.
 In some cases, loans are secured against the assets of the business or your personal possessions, e.g. your home.
The interest rates for secured loans may be lower than for unsecured ones, but your assets or home could be at
risk if you cannot make the repayments.
 There may be a charge if you want to repay the loan before the end of the loan term, particularly if the interest
rate on the loan is fixed.
TRADE CREDIT
OPEN ACCOUNTS
PROMISSORY NOTES
BILL PAYABLE
TRADE CREDIT
• An arrangement to buy goods or services on account, that is, without making immediate cash payment
• For many businesses, trade credit is an essential tool for financing growth.
• Trade credit is the credit extended to you by suppliers who let you buy now and pay later. Any time you take
delivery of materials, equipment or other valuables without paying cash on the spot, you're using trade credit.
• Is the most common source of spontaneous short-term finance for a business. In such an agreement, the seller is
the lender, allowing the buyer to pay at a later date than it actually took possession of goods. Such a source of
short-term finance is used to meet working capital needs. Trade credit is also very important for many businesses
since they may have difficulties raising other sources of debt financing.
Types of Trade Credit

 Open account or open credit- operates as an informal arrangement wherein the supplier after satisfying
himself about the credit worthiness of the buyer, dispatches the goods as required by the buyer and send the
invoice with particulars of quantity dispatched, the rate and total price payable and the payment terms. The
buyer records his liability to the supplier in his books of accounts and this is shown as payables on open account.
The buyer is then expected to meet his obligation on the due date.
 Promissory note- is a formal document signed by the buyer promising to pay the amount to the seller at a
fixed or determinable future time. Where the client fails to meet his obligation as per open credit on the due
date, the supplier may require a formal acknowledgement of debt and a commitment of payable by a fixed date.
The promissory note is thus an instrument of acknowledgement of debt and a promise to pay. The supplier may
even stipulate an interest payment for the delay involved in payment.
Bills payable or commercial draft- are instruments drawn by the seller and accepted by the buyer for
payment on the expiry of the specified duration. The bill or draft will indicate the banker to whom the amount
is to be paid on the due date, and the goods will be delivered to the buyer against acceptance of the bill. The
seller may either retain the bill and present it for payment on the due date or may raise funds immediately
thereon by discounting it with the banker. The buyer will then pay the amount of the bill to the banker on the
due date.
8 DETERMINANTS OF TRADE CREDIT
1.SIZE OF FIRM
Smaller firms have increasing dependence on trade credit as they find it difficult to obtain alternative sources of finance as
easily as medium or large-sized firms. At the same time, larger firms that are less vulnerable to adverse turn in business can
commence prompt credit facility from supplier, while smaller firm may find it difficult to sustain credit worthiness during periods
of financial strain and may have reduced access to credit due to weak financial position.

2. INDUSTRIAL CATEGORIES
Different categories of industries or commercial enterprises show varying degree of dependence on trade credit. In certain
lines of business, the prevailing commercial practices may stipulate purchases against payable in most cases. Monopoly firms
may insist on cash on delivery. There could be instances where the firm’s inventory
turnover every fortnight but eh firm enjoys thirty days credit from suppliers, whereby the trade credit not only finances the firm’s
inventory but also provides part of the operating funds or additional working capital.
3. NATURE OF PRODUCT
Products that sell faster or which have higher turnover may need shorter credit term. Products which have slower turnover
take longer to generate cash flows and will need extended credit terms.

4. FINANCIAL POSITION OF SELLER

The financial position of the seller will influence the quantities and period of credit wishes to be extended. Finally weak
supplier will have to be strict and operate on higher credit terms to buyers. Finally stronger suppliers, on the other hand, can
dictate stringent credit terms but may prefer to extent liberal credit so long as the transactions provide benefits in excess of the
costs of extending credit. They can afford to extend credit to smaller firm and assume higher risks. Suppliers with working capital
crunch will be willing to offer higher cash discount to encourage early payments.
5. FINANCIAL POSITION OF THE BUYER
Buyer’s credit worthiness is an important factor in determining the credit quantum and period. It may be logical
to expect large buyers not to insist on extended credit terms from small suppliers with weak bargaining power.
Where goods are supplied on a consignment basis, the supplier provides extra finance for the merchandize and pay
commission to the consignee for the goods sold. Small retailers are thus enabled to carry much larger levels of
stocks than they will be able to finance by themselves. Slow paying or delinquent accounts may be compelled to
accept stricter credit terms or higher prices for products to cover risk.

6. DEGREE OF RISK
Estimate of credit risk associated with the buyer will indicate what credit policy is to be adopted. This risk may
be with reference to buyer’s financial standing or with reference to the nature of the business the buyer is in.

7. CASH DISCOUNT
Cash discount influences the effective length of credit. Failure to take advantage of the cash discount could
result in the buyer using the funds at an effective rate of interest higher than that of alternative sources of finance
available. By providing cash discount and inducing good credit risks to pay within the discount period, the supplier
will also save on the costs of administration connected with keeping records of dues and collecting overdue
accounts.
8. NATURE AND EXTENT OF COMPETITION
Monopoly status facilitates imposition of tight credit terms whereas intense competition will promote the
tendency to liberalize credit. Newly established companies in competitive field may more readily resort to liberal
trade credit for promoting sales than established firms which are more formal in deciding on credit policies.
Advantages and Disadvantages of Trade Credits
Advantages:
1.Quick to arrange. The buyer may easily arrange and maintain such an agreement as long as the conditions are
met.
2.No collateral required. The buyer is not supposed to provide to the seller any collateral or security.
3.Flexibility. This source of spontaneous short-term financing meets the matching principle. In other words, the
buyer raises financing exactly for that period and the amount it needs.
Please also note that trade credit remains the only source of short-term financing. This is especially true for new and
growing businesses that are having trouble meeting the requirements of other creditors, e.g., banks.
Disadvantages:
1.High cost. It usually has much higher costs than other sources of short-term financing, such as bank loans or lines
of credit, because the credit risk is higher and no collateral is involved.
2.Decrease in creditworthiness. As we have mentioned above, the longer the net period, the lower cost of trade
credit, but this results in a growing balance of the “Accounts Receivable” account. In turn, it leads to an increase in
current liabilities and a decrease in liquidity, which may be negatively perceived by other creditors.
3.Indirect costs. As a rule, the cost of trade credit is included in the price of goods. In other words, the seller offers
different prices for different payment terms. For example, cash on delivery usually assumes a lower price for the
same goods than “net 30.” Higher prices compensate credit risk and higher financing costs of the seller.
MICRO CREDIT
PROGRAMS
FARMER-TO-FARMER PROGRAMS
INTEGRATED ECONOMIC SUPPORT
TRAINING CENTERS
HEALTH INFORMATION PROGRAMS
INDIVIDUAL INVESTORS
MICRO CREDIT

• is an extremely small loan given to impoverished people to help them become self-employed. Microcredit is also
known as "micro lending" or "microloan."
• is the extension of very small loans (microloans) to impoverished borrowers who typically lack collateral, steady
employment, or a verifiable credit history. It is designed to support entrepreneurship and alleviate poverty. Many
recipients are illiterate, and therefore unable to complete paperwork required to get conventional loans.
5 innovative microcredit programs in developing Rural Areas

1. Farmer-to-Farmer Programs:
Microcredit programs tend to be most sustainable when they promote cooperation between residents of a
community. Encouraging farmer-to-farmer support can be an effective technique because it allows participants to
be less reliant on outside financing and guidance. Farmer-to-Farmer Programs in Action: When Africa’s Sustainable
Development Council (ASUDEC) connects farmers with microcredit loans, the recipients have several expectations
placed upon them. ASUDEC requires farmers to not only pay back the loans, but also to offer equally affordable
loans to their neighbors. This policy generates a ripple effect, helping communities increase their incomes and fund
their own progress, rather than relying on ASUDEC. As the trust and cooperation between farmers builds, it “helps
the poor transition from subsistence to entrepreneurship,” says ASUDEC’S Director, Dr. Salibo Some.
2. Integrated Economic Support:
While gaining access to affordable lines of credit is an important step for poor farmers, it isn’t always enough to
provide real financial stability. Some microcredit programs go beyond small loans and offer many services such as
connections to markets, supply regulation, and savings accounts. Integrated Economic Support in Action: BRAC,
formerly Bangladesh Rural Advancement Committee, started its microfinance program in 1974 in Bangladesh, and
now provides asset- and referral-free microloans to impoverished people in 16 countries. The largest development
organization in the world, BRAC’s aim is to “use microfinance groups as a social platform to deliver scaled-up
services in health, education, business development and livelihood support.” They provide specialized loans (US$50-
700) and training for young women, and larger loans (US$700-7000) to existing small enterprises. All of these loans
come with access to a range of services, including savings, technical assistance, and marketing. Over 99 percent of
BRAC’s 7 million borrowers pay back their loans on time.
3. Training Centers:
Without the necessary knowledge and training, many farmers who receive microloans would struggle to
increase their production and pay back loans. Most microcredit programs, therefore, link their loans with training
and education on up-to-date techniques and practices. Training Centers in Action: Ecova Mali was started in 2007 in
order to provide grassroots development in Mali. The two main thrusts of their program are providing farmers with
training in sustainable agriculture, and offering micro financing (loans and grants) to help farmers start
environmentally and socially responsible enterprises. They have a permanent training facility in Mali, where local
experts teach their fellow Malians new techniques, such as using natural fertilizers, aquaculture, and biogas, and
explain why they are preferable to traditional methods. Once they receive the education, the farmers may be
offered loans or grants to get started on their own eco-friendly, profitable farms.
4. Health Information Programs:
The history of microcredit programs is not spotless. Financiers have occasionally preyed upon the poor, profiting
substantially from microloans. And sometimes loans have proven to be ineffective at delivering immediate relief and
aid. One tactic employed by some programs is to link loans directly with health information and care. Health
Information Programs in Action: The Microcredit Summit Campaign was originally launched in 1997 in Washington,
DC, as an international effort to bring access to credit to millions of the world’s poorest people, especially women.
One important facet of their mission is to work with a network of trainers to reach “over half a million microfinance
clients in eighteen countries with life-saving health education lessons.” This is crucial to combat insufficient
knowledge of nutrition, sanitation, HIV/AIDS, and many other health-related issues. The Campaign is specifically
trying to establish self-sustaining education systems through microloans which are independent of donor support.
5. Individual Investors:
Sometimes NGOs and governments fail to provide services where and when they are needed. Dedicated
individuals, however, can contribute immeasurably to their communities by utilizing and encouraging micro
financing and partnerships that build trust and cooperation. Individual Investors in Action: Dinnah Kapiza, an agro
dealer in Malawi, lost her husband in 1999, and she responded by taking a training course in business that came
with a microloan. She used that money to start a new agro-dealership, Tisaiwale Trading, which sells agricultural
supplies, such as seeds and tools, to roughly 3,000 nearby farmers in Malawi. Her business is flourishing, providing
affordable supplies and technical training on how to best use them, and she is working to connect women’s
groups to their own microcredit.
 NEGOTIATING
TERM LOANS
TIPS FOR BUSINESS OWNERS:
BE PREPARED
UNDERSTAND YOUR TERMS
CONSIDER A DEEPER RELATIONSHIP WITH YOUR BANKER(S)
CHECK POUT THE COMPETITION
CLEARLY UNDERSTAND THE TERMS
SEEK GOOD ADVICE
Be prepared:
Have up-to-date CPA-prepared financials ready for the bank to review at the time of your loan request. Be sure
to include at least two years of historical comparative P&Ls and Balance Sheet information and the most recent
trailing 12 months on all business entities as well as any management companies. Provide written explanations of
any one-time credits or expenses and also any changes that have been made that will affect any of the sales or
expenses. Have a Personal Financial Statement prepared for your lender to review that accurately reflects your
current personal financial position.

Understand your terms:

When you talk with your banker be sure to look at all the alternatives: short term notes, revolving lines of
credit, traditional bank-term loans, weighted average-term notes, fixed rates and floating/variable rates. What is
your monthly payment and is it fixed or variable each month? Can you pay down or pay off the loan early without
any financial penalty? What other costs and fees may be associated with the loan?

Consider a deeper relationship with your banker(s):

Developing a robust relationship with the bank(s) you do business with may be another way to be rewarded
with favorable pricing and terms. Banks typically negotiate better pricing on your credit deal if you also have
depository business and/or a commercial credit card with them. Build a foundation for a lasting banking relationship
that is beneficial for you and for the bank. Longstanding bank relationships can add ease of doing business and extra
value to your organization.
Check out the competition:
Creating some competition among banks is often an easy way to improve the terms of the deal. Work with your
accountant to put together a short document that outlines your debt requirements for the next 3 – 5 years. Invite
well qualified banks to provide you with a proposal and pricing that helps your company reach those goals. Compare
terms and interest rate options to make the best choice.

Clearly understand the terms:

What are the loan covenants and how often are they reviewed? What happens to the loan and/or pricing if you
have a covenant breach? Is your interest rate fixed or floating? Do you have prepayment penalties or rate breakage
fees? Is the loan assumable by a family member if you shift ownership of your business within the family? What is
being used as collateral? How do you have that collateral released if you sell all or part of your business holdings?

Seek good advice:

Consult with your banker and your CPA to determine what debt structure serves you best, not just for the
immediate borrowing need, but for any future borrowing needs.