Understanding debt finance
18th October 2013
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Many small businesses need to look for external funding at some stage, with debt finance being one of the most common sources for both start-ups and existing businesses.

 

Most debt finance takes the form of a loan to your business that ultimately has to be repaid to the lender. The cost to your business is the repayment of the principal sum; interest incurred on it and any additional fees, such as arrangement and valuation fees.

 

The following are types of debt finance:

  • Bank loans
  • Commercial mortgages
  • Overdrafts
  • Credit cards
  • Factoring and invoice discounting
  • Asset finance
  • Credit terms with suppliers

 

The most appropriate type of debt finance for your business depends on a number of factors. You should think carefully about:

 

  • How much you need to borrow
  • What the money will be used for
  • The period of the loan
  • The security required
  • The repayments your business can afford
  • The level of risk you are comfortable with

 

How much should you borrow?

To help you decide how much to borrow, look at what the money is to be used for and estimate the costs of borrowing the money. You will also need to prepare a detailed cash flow forecast for your business and include the capital repayments, interest and any fees associated with the debt. This will allow you to see whether your business can manage the costs of the debt.

 

In order to decide whether to lend you money, lenders will require the following information

 

  • Accounts for the last two years (preferably prepared by an accountant)
  • Budgets and cash flow forecasts
  • Details about customers (especially for factoring and invoice discounting)
  • Details about business assets for security
  • Details about your personal financial position, CV and assets owned (and the same information for other directors/owners)
  • Business bank statements

 

What are the risks?

The ultimate risk is that you will not be able to make the necessary repayments due to a decline in sales or for some other reason. The lender could seize and sell the business’ assets provided as security to pay off the remaining debt. If you have given a personal guarantee, you will have to pay the debt yourself, which may require you to sell personal assets.

 

Hints and tips

  • Plan ahead. It can take time to secure the right form of debt finance. Prepare detailed forecasts that can be provided to potential lenders.
  • Consider the types of debt finance available to your business. You may want to discuss this with your accountant or other business adviser.
  • Work out how much you actually need to borrow. Be realistic; if you do not borrow enough it might be difficult to go back for more. Similarly, you do not want to borrow too much and pay interest.


By David White, Partner, Charterhouse, based in Beaconsfield

 

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About the Author

David W

Member since: 16th May 2013

David White is an equity partner in Charterhouse a practising firm of Chartered Accountants based in Beaconsfield and Harrow. David is Charterhouse through and through having been with them for 30 years...

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