Advantages and Disadvantages of Different Sources of Finance

In this article let's evaluate some of the pros and cons of different sources of finance in order to identify which one works best for your business. First of all, if a company is going to consider long-term bank loans, the major advantage is that they can be provided for the large sums. Since long-term bank loans as its name indicates, provided for a long period of time, the repayment process is more comfortable compared to the short-term debts.

Companies can utilize the money wisely, and without any pressure close the loan during the given period of time. However, since the interest rate is extended to the whole period, long-term debts can be a heavy bag, especially with the appearance of economic problems. Despite this, businesses must comply with bank requirements, otherwise they will not be approved for this type of finance.

Another option is hire purchase, this one may be used by a company which does not have sufficient funds to obtain an asset, and through this instrument can establish asset acquisition where payments will be made by instalments over a given period of time. At the end of the period the hirer is a legal owner of the asset, and during repayment period the asset can be used by the company without any restriction. However, the drawback of this method is that any delayed payment has a negative effect on a company's credit rating.

Leasing is also a very convenient option, especially when a company needs to obtain an asset for a short-period of time, therefore it is more practical to lease an asset instead of purchasing. It is a very rational approach, to use hire purchase when the asset is needed for the long-run operations, and to use leasing for short-run. Another beneficial instrument is a trade credit, which is most commonly used by companies from all industries. Since it allows for companies to buy now and pay later, it’s very useful for bridging the financial gap between cash outflow and inflow. Once the company agreed with suppliers to pay money later, they shortened the funding gap and saved the cash, thereby increasing liquidity. Last but not least, the line of credits has a great advantage over the regular loans. One of the major advantages of this option is that as long as you use them under the limit, they can be very versatile. Such versatility allows businesses to handle cash flow issues from time to time. The line of credit is also cheaper than other options, therefore it can be used by low-margin companies. However, this option also has some pitfalls. One of the main disadvantages is the difficulty of obtaining a line of credit, since it's available for companies which have capital and record of investing. Another disadvantage is when companies need more cash, it is hard to get a raise of available funds. When business is growing rapidly, and has exceeded the credit limit, this restriction could create a serious issue. The businesses are required to consider all key factors before choosing any sources. These factors include the period of time involved, as well as the size of the organization. In addition, there is always some risk involved, and relying on one particular source of finance is not always a good idea. Through a mix of available sources of finance, companies can capture value from all of them, shortening the funding gap and gaining an optimal level of liquidity.

By Adil Maidanov | 20 November 2020

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