Essential Business Finance and Loan Insights

Posted on Jul 16, 2025 in Economy

Sources of Business Finance Beyond Traditional Lenders

Sources of finance for businesses include:

Equity: Funds raised by selling ownership shares.
Debt: Borrowed money that must be repaid, often with interest.
Debentures: Long-term debt instruments issued by companies.
Retained Earnings: Profits kept by the business for reinvestment rather than distributed to shareholders.
Term Loans: Loans repaid over a set period with fixed or variable interest rates.
Working Capital Loans: Short-term loans to cover day-to-day operational expenses.
Letter of Credit: A bank’s guarantee of payment to a seller.
Euro Issue: Raising capital from international markets.
Venture Funding: Capital provided to startup companies with high growth potential.

Sourcing Equity Finance

Equity finance can be sourced from various avenues:

Business Angels: Wealthy individuals who provide capital for a startup or small business, usually in exchange for ownership equity.
Venture Capital: Funds provided by venture capital firms or funds to small, early-stage, emerging firms that have been deemed to have high growth potential.
Crowdfunding: Raising small amounts of money from a large number of people, typically via the internet.
Enterprise Investment Scheme (EIS): A UK government scheme designed to help smaller, higher-risk trading companies raise finance by offering tax reliefs to investors who buy new shares in those companies.
Alternative Platform Finance Schemes: Digital platforms facilitating various forms of finance, including peer-to-peer lending and equity crowdfunding.
The Stock Market: Public offering of shares (Initial Public Offering – IPO) for larger, established companies.

Benefits of Equity Finance

Equity finance offers several distinct advantages:

There is no obligation to repay the money acquired, as it represents ownership, not a loan.
It provides equity investors with a good return on their investment without requiring fixed payments or interest charges, unlike debt financing.
It can increase a business’s capacity for future borrowing, as it strengthens the balance sheet and reduces debt-to-equity ratios.
It is generally considered a permanent source of finance, as the capital does not need to be repaid unless the company is liquidated or shares are bought back.

Factors Influencing Bank Loan Interest Rates

Bank loan interest rates are dependent on several key factors:

Debt-to-Income Ratio: This ratio equals your total monthly debt payments divided by your gross monthly income. A lower ratio generally indicates less risk and may lead to a better interest rate.
LIBOR (London Interbank Offered Rate) / Benchmark Rate: This is a benchmark interest rate at which major global banks lend to one another in the international interbank market for short-term loans. Many variable-rate loans are tied to LIBOR or similar benchmark rates (e.g., SOFR).
Prime Rate: This is the interest rate that commercial banks charge their most creditworthy corporate customers. It is typically above the Federal Funds Rate but a few points below the average variable interest rate for consumers.
Creditworthiness: Your credit history and score significantly impact the perceived risk by the lender.
Loan Term and Type: Longer loan terms or certain loan types (e.g., unsecured personal loans) may carry higher interest rates.

Duration of Bank Loan Debt

A bank loan remains a debt until the entire principal amount and all accrued interest have been fully repaid according to the loan agreement terms. The duration can vary significantly, from short-term loans (e.g., a few months to a year) to long-term loans (e.g., 15-30 years for mortgages).

Interest Calculation on Bank Loans

Interest on a bank loan is primarily calculated on the outstanding principal balance of the loan. As you make payments, a portion goes towards interest and a portion towards reducing the principal. The interest for the next period is then calculated on the new, lower principal balance (for amortizing loans).

Loan Interest as a Tax Deduction

Interest paid on certain types of loans can be regarded as a tax deduction, effectively reducing your taxable income for the year. However, personal loan interest is generally not tax deductible. Common types of loans where interest may be deductible include:

Mortgages: Interest on home mortgages (for primary residences and sometimes second homes) up to certain limits.
Student Loans: Interest paid on qualified student loans.
Business Loans: Interest on loans used for business purposes.

It is crucial to note that specific criteria and limits must be met to qualify for these deductions, and tax laws vary by jurisdiction. Consulting a tax professional is always recommended.

Situations for Using a Bridging Loan

A bridging loan is a short-term loan designed to “bridge” a financial gap, typically used in property transactions. A common situation where a bridging loan may be used is when you are buying a new property before you have sold your current one. This allows you to complete the purchase of your new home without waiting for the sale of your existing property to finalize.

Key considerations for a bridging loan include:

You may need to service both your original home loan and the bridging finance loan simultaneously for a period.
Lenders will require evidence that you can repay the bridging finance interest costs during the interim period between buying and selling.
Once your original property is sold, you typically have a set period (e.g., up to 12 months) to repay the bridging loan from the proceeds of the sale.

Assets for Short-Term Loans

For short-term loans, especially when a business may not qualify for a traditional bank line of credit, various assets can be used as collateral or form the basis for the loan. These loans are often used to finance temporary working capital needs. Assets that may be used include:

Accounts Receivable: Outstanding invoices from customers (receivables financing or factoring).
Inventory: Raw materials, work-in-progress, or finished goods.
Equipment: Machinery, vehicles, or other business equipment.
Cash Flow: Future predictable cash inflows (e.g., merchant cash advances based on credit card sales).
Real Estate: Though less common for short-term specific loans, it can be used for secured loans.

The specific assets accepted depend on the lender and the type of short-term financing.

Information Lending Authorities Request for Loan Approval

Before approving a loan, lending authorities typically wish to gather comprehensive information about an applicant to assess their creditworthiness and repayment capacity. Key information includes:

Credit History: Evidence of clean financial habits and overall financial health, including past repayment behavior, existing debts, and credit scores.
Occupation and Income Stability: Details about your employment, job stability, and consistent income source to ensure repayment capability.
Age: While not a direct disqualifier, age can influence risk assessment, with applicants typically between 30-50 often considered financially stable. Older applicants (e.g., 60+) might face more scrutiny in internal bank scoring models regarding long-term repayment capacity.
Residential Stability/Distance: Sometimes, proximity to the financing branch or property location (e.g., within city municipality) might be preferred by some local lenders, though this is less common for larger institutions.
Spouse’s Income Source: If applicable, details about a spouse’s stable job and income can significantly enhance the household’s overall repayment capacity.
Assets and Liabilities: A complete picture of your financial standing, including savings, investments, other properties, and existing debts.
Purpose of the Loan: Understanding how the funds will be used.