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Study notes

Sources of Finance: Bank Loans

  • Levels: AS, A Level
  • Exam boards: AQA, Edexcel, OCR, IB

Bank loans are popular external sources of medium and long-term finance for businesses.

What is a Bank Loan?

A bank loan is an amount of money borrowed for a set period within an agreed repayment schedule. The repayment amount will depend on the size and duration of the loan and the rate of interest.

Many businesses use bank loans as a suitable part of their financial structure. In fact, bank loans tend to be more available for well-established and growing businesses rather than start-up businesses.

The reason for this is risk – banks prefer to loan to businesses with an established track record of profitability, which makes them more likely to be able to repay the loan and interest.

If a bank loan can be obtained, then there are several advantages for a growing business:

  • The business is guaranteed the money for a certain period - generally three to ten years (unless it breaches the loan conditions)
  • Loans can be matched to the lifetime of the equipment or other assets the loan is for
  • While interest must be paid on the loan, there is no need to provide the bank with a share in the business
  • Interest rates may be fixed for the term, making it easier to forecast interest payments

The main disadvantage of a bank loan is the security that usually has to be given to the bank over the assets of the business. The bank becomes a secured creditor with collateral over the business assets. If the business fails, then the bank has first call on what is left (before the shareholders).

Another disadvantage of a bank loan is its relatively lack of flexibility. A growing business might take a loan out for £500,00 but finds it only needed £250,000. That means that interest is being paid on £250,000 of excess finance.

Sources of Finance - Bank Loans

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