WORLD ACADEMY OF INFORMATICS AND MANAGEMENT SCIENCES
ISSN : 2278-1315
f. A company can offer security in order to secure a
Consequently:
a. The advantage of a bank overdraft is that the
loan.
borrower pays interest only on the amount of the
When Bank Loan is appropriate
overdraft balance.
a. Short term loans are suitable for funding smaller
b. However, overdrafts are expensive (the interest rate
investments.
is comparatively high compared with other sources
b. Long term loans are suitable for funding major
of finance). Overdrafts are also repayable to the
investments.
bank on demand. The bank can ask for immediate
Hybrids Financing
repayment at any time that it wishes. Overdrafts
Hybrid financing is the financial instrument that partakes
can therefore be a high-risk source of finance,
some characteristics of debt and some characteristics of
especially for businesses with cash flow difficulties
equity. The important forms of Hybrid Financing are
– in other words, the businesses that are usually in
Preference Capital, Convertible Debentures, Warrants,
greatest need of an overdraft!
Options, Innovative hybrids and so on.
c. Bank overdrafts should only be used to finance
Features of Hybrids Financing
fluctuating levels of cash shortfalls. If the cash
a. A hybrid is a financial instrument that combines
shortfall looks more permanent, other sources of
features of equity and debt for example, convertible
finance should be used.
debt.
b. Interest is paid at an agreed rate for a specified
Features of Bank Overdrafts
a. Flexible with regard to amount and available
period. At the end of the period the holder can
immediately within pre-arranged limits.
choose to be repaid in cash or to change the debt into
b. Interest and fees are tax deductible.
equity shares. Whether or not conversion occurs
c. Interest is only paid when the account is
depends on the share price at the conversion date.
overdrawn.
c. The issuing company will to raise cash in order to
d. Penalties for breaching overdraft limits can be
pay back the amount if conversion is not chosen.
severe.
d. Lower interest rates than straightforward (vanilla)
e. Overdrafts are repayable on demand.
debt as the lender is, in effect, lending money and
buying a call option on the company’s shares.
When Bank Overdraft is Appropriate
a. Used to finance day to day operations.
e. Interest and fees are tax deductible.
b. An important component of working capital
When Hybrids Financing is appropriate
management policies
a. For long term investments.
b. Useful if the share price is low at the time of issue
Bank Loans
In finance, a loan is the lending of money by one or more
thus making equity issue too dilutive.
individuals, organizations, or other entities to other
Leases Financing
individuals, organizations etc. the recipient incurs a debt,
Lease financing is one of the important sources of medium-
and is usually liable to pay interest on that debt until it is
and-long-term financing where the owner of an asset gives
repaid, and also to repay the principal amount borrowed.
another person, the right to use that asset against periodical
The main difference between a loan and a bank overdraft is
payments. The owner of the asset is known as lessor and the
that a loan is arranged for a specific period and the capital
user is called lessee.
borrowed, together with the interest, is repaid according to
Finance leases are a form of debt finance. Companies can
an agreed schedule and over an agreed time period. They are
acquire assets with leasing finance instead of buying assets
not repayable on demand before maturity, provided the
with equity or debt capital. Operating leases are a means of
borrower keeps up the payments. Interest is payable on the
acquiring assets for the fairly short term. Finance leases are
full amount of the outstanding loan. However, the bank may
similar to operating leases, except that the lease agreement
demand security for a loan, for example in the form of a
covers most or all of the asset’s expected economic life.
fixed and floating charge over the assets of the business.
For financial reporting purposes, the principle of ‘substance
Short-term bank loans might be arranged for a specific
over form’ applies. The leased asset is reported in the
purpose, for example to finance the purchase of specific
statement of financial position (balance sheet) of the lessee as
items. Unlike an overdraft facility, a bank loan is for a
a non-current asset. This is matched (initially) by a long-term
specific period of time, and there is a repayment schedule.
debt obligation to the lessor, which is gradually paid off over
the term of the lease.
Features of Bank Loans
a. Available for specified periods and must be repaid
This means that for financial reporting purposes, lease finance
according to a pre agreed schedule. This means that
is actually reported in the statement of financial position
the company knows where it stands in terms of
(balance sheet) as a debt obligation, and the regular lease
needing to meet cash payments.
payments are reported as a mixture of finance costs (interest)
b. Interest and fees are tax deductible.
and repayment of the obligation to the lessor.
c. Once the loan is taken interest is paid for the
Features of Lease Financing
duration of the loan.
a. Two types:
d. A loan might be repayable if loan covenants are
i.
Operating leases – off balance sheet
breached but failing that the cash is available for
ii.
Finance leases – on balance sheet
the term of the loan.
b. Legal ownership of the asset remains with the lessor.
e. Can be taken out in a foreign currency as a hedge
c. Lessee has the right of use of the asset in return for a
of a foreign investment.
series of rental payments.
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