What is the process of Bank Overdraft and Bank Loan | Chris Virgin

WHAT IS THE PROCESS OF BANK OVERDRAFT AND BANK LOAN CHRIS VIRGIN REVIEWS

LEARNING OBJECTIVES: •

Short Term Finance

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Sources of Short Term Finance

Factoring and Invoice Discounting

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Bills of Exchange

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Bank Overdraft

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Trade Credit

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Short Term Finance Short term finance usually refers to the loans mostly offered on terms of up to 12 months. Short term finance is needed to meet the working capital requirements of the business.

Total funds (£)

Fluctuating current assets

Permanent current assets

Short-term finance

Long-term finance

Non-current assets

Time

Short Term Finance-Sources Trade Credit

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Bank Credit

Loan

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Factoring (and Invoice Discounting)

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Bills of Exchange

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Overdraft

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Trade Credit (Suppliers)

The supplier typically provides the customer with an agreement to bill them later, stipulating a fixed number of days or other date by which the customer should pay.

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This is the basic source of finance and many entrepreneurs do not realise that by acquiring items on credit they are obtaining short term finance.

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Tesco and ASDA typically have over twice as much owing to suppliers at any one time as the value of all the goods on their shelves – more than £2.2bn for Tesco and £ 1.5bn for ASDA.

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Trade credit is an arrangement between businesses to buy goods or services on account, that is, without making immediate cash payment.

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The Credit Trade-off

Trade credit • Advantages of trade credit –1 –2

Convenient/informal/cheap Available to companies of any size

• Factors determining the terms of trade credit – 1 Tradition within the industry – 2 Bargaining strength of the two parties – 3 Product type – 4 Credit standing of individual customers

BANK CREDIT Bank Overdraft –

Bank Loans –

Bills of Exchange –

Debt Factoring

with a financial institution (subsidiaries of banks)

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with Banks and Traders

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with Banks

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with Banks

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Bank Overdraft • Overdraft – An overdraft is a permit to overdraw on an account up to a stated limit.

– A major saving comes from the fact that the banks charge interest on only the daily outstanding balance.

• Advantages of overdrafts – 1 Flexibility – 2 Cheapness • Drawbacks of an overdraft – The bank retains the right to withdraw the facility at short notice – Security- In 2001 Lloyds TSB took 51% shares owned by Sir Richard in Virgin Atlantic as security, in return, Sir Richard Branson got a £67m three-year overdraft facility.

BANK LOANS (MEDIUM AND LONG TERM)

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Bank loans are flexible in the length of time.

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A term loan often has much more accompanying documentation than an overdraft.

Term loan is a loan of a fixed amount for an agreed time and on specified terms (usually between three and seven years).

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DISTINCTION BETWEEN BANK OVERDRAFT AND BANK LOAN

Renewal Procedure

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Issue of Security

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Flexibility

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Repayment

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Amount of Borrowing

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Charge of Interest

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Overdraft vs term Loan (1 Year) The management of Fruit Growers plc are trying to decide whether to obtain financing from an overdraft or a loan. The interest on both would be 10% per year or 2.5% per quarter. The cash position for the forthcoming year is represented as following. The excess (surplus) cash (funds) can be invested at 2% per quarter.

Which is better Overdraft or Loan?

Monthly cash flow balance for Fruit Growers plc

Fruit Growers plc (Continued)

TRADE CREDIT VERSUS BANK CREDIT Repayment for trade credit has to be made, while repayment for bank credit is renewable.

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No (Has) interest on trade (bank) credit.

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No security is required in trade credit.

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Trade credit serves a limited purpose, while bank credit can be utilised for any purpose.

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DEBT FACTORING

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Three parties involved: the one who sells the receivable, the debtor, and the factor.

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The sales of the receivables transfers ownership of the receivables to the factor.

Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (factor) at a discount in exchange for immediate money.

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