Sources of finance for small business

A small business has two broad ways to fund its activities. Equity is money contributed by the owner (capital) or kept in the business as retained profit. Debt finance is money or credit supplied by an outside party that must be repaid, usually with interest or some other cost. This topic deals with sources other than equity, which means the business takes on a liability.

Short-term sources are repaid within twelve months and are normally used to fund day-to-day needs such as buying inventory, paying wages while waiting for customers to pay, or smoothing seasonal cash shortages.

• Bank overdraft: an arrangement allowing the business cheque or transaction account to go below zero up to an agreed limit. Interest is calculated daily on the amount actually overdrawn, and the bank also charges fees such as an establishment fee and a line fee on the whole limit.
• Trade credit: a supplier delivers goods or services now and allows payment later, for example within 30 days. It is recorded as accounts payable. Suppliers may offer a discount for early payment, so not taking the discount is a hidden cost of the credit.
• Business credit card: a revolving line of credit for small purchases, often with an interest-free period if the balance is cleared in full by the due date, but a high interest rate on unpaid balances.
• Debtor (invoice) finance: a financier lends against outstanding customer invoices (or, in factoring, buys them at a discount), so the business receives cash before its accounts receivable are collected, at a cost in interest, fees or discount.

Australian banks, credit unions, non-bank lenders and suppliers all provide these products. When a question names a source, always identify whether it is short term or long term, what it costs and how flexible it is.