At debt's door?

Finance is the lifeblood of business. Few organisations could thrive, or even survive, without some form of credit to bridge the gap between investment and returns. But finance takes many forms and can be costly. Getting the right type of finance, or the right mix of types, can be critical.

Different forms of finance have their own advantages and disadvantages and suit different purposes.

The bank overdraft is the most basic and flexible form of credit. Within a prearranged limit, a business can dip in and out of the facility as necessary.

Overdrafts are intended to be used for working capital, typically financing raw materials and stocks and, in recent years, banks have taken steps to reinforce this. Security is usually required, and the chief disadvantage is that the bank can demand instant repayment. Interest rates on overdrafts are usually between 2% and 5% above the base rate.

Fixed-term loans are used to fund investment in capital, either for starting up or expanding a business. Regular repayments are required, but a holiday on capital repayments may be available.

A fixed interest rate will take some uncertainty out of business planning, but may add a percentage point or two to the cost. The term can be quite long, sometimes up to 20 years: NatWest says its average for small businesses is seven years, while 31% of Barclays' term loans are for 10 years or more. There will probably be a minimum borrowing of £1,000 or more and security may be required.

Credit cards

Credit cards are useful for buying in supplies and incidentals, such as stationery. No security is required with them and their use is interest-free, as long as it is paid off monthly.

Leasing or hire purchase can be used tax-efficiently to acquire any item of equipment in normal use in the business or industrial environment and from a value of a few hundred pounds or more. Purchases may be financed through banks or through the vendors' own schemes.

For specialised equipment, such as computers, companies may need to use a specialist finance firm. But it is important to compare costs and look out for deals that outlast the useful life of the kit.

Invoice discounting is where money owed to the business is treated as an asset. A factoring house advances credit against invoices issued by the company, usually up to 80% of their face value. It then collects the payment and pays the business the balance, less a service charge. The service is only available on business debts, and to businesses with a minimum turnover of about £75,000 a year.

Full-service factoring means the factoring house takes over a company's bookkeeping, including the collection of payments and the chasing of bad debts. With invoice discounting, these procedures are kept in-house and customers are unaware of them.

One benefit of this form of finance is that it takes pressure off the company's overdraft and is useful for expanding firms that need to buy in more raw materials or stock than past sales can cover. Interest rates charged should be comparable to overdrafts, but the cost of allied services may make direct comparison difficult.

Asset-based finance is where the value tied up in a firm's activities are identified and used as security for further working capital. It is useful for firms that are expanding and may otherwise be in danger of overtrading. It can also smooth the way for seasonal businesses.

Another way of injecting finance into a business is to sell a bit of it. The business does not have to be big to do this, but it does have to be growing, or at least be capable of growth.

Venture capital

Major venture capital finance houses are generally interested only in investing six-figure sums or more - the average is just over £1m - because the work involved does not generally make lesser investments worthwhile.

A number of regional funds are geared up to consider smaller propositions of £10,000 or less, as are private individuals, or so-called business angels.

Unlike bank loans, which are secured on realisable assets such as the company owner's house, venture capital financing is unsecured. Venture capital investors share the risks of the companies they back, and share proportionately in any rewards.

Taking equity finance may mean relinquishing a degree of control over how the business is run, but it may also mean a useful injection of management expertise along with the cash. Business angels are usually looking for hands-on satisfaction as well as financial rewards, but all funds are there to provide support to protect their investment.