Key Concepts
A business does not always have enough cash of its own to do everything it wants — to buy equipment, open a new branch, or build up inventory. One way to raise the cash is to borrow from a third party such as a bank or a finance company. In return, the lender charges interest — the cost of borrowing the money.
When a business borrows money that it will repay over more than one financial year, the amount owed is called a long-term borrowing — shown as a non-current liability in the Statement of Financial Position. The loan is usually for a fixed number of years, and the business repays it either in regular instalments (fixed amounts paid back at set times) or as one lump sum (a single payment) at the end of the loan period.
The current portion of a long-term borrowing. Part of a long-term loan can fall due soon — within the next financial year. At each year-end, that part is split off and shown separately as a current liability, while the rest stays as a long-term borrowing. You will do this split when presenting the loan in the financial statements (covered later in this chapter).
Bank loan vs bank overdraft. Both involve owing money to the bank, but they are very different liabilities:
| Point of difference | Bank loan | Bank overdraft |
|---|---|---|
| Amount borrowed | A fixed amount agreed at the start. | Not fixed — the business can overdraw up to an agreed limit. |
| Is cash transferred in? | Yes — the loan amount is paid into the bank account. | No — the business simply withdraws more than what it has in the bank. |
| How is it repaid? | By regular cash payments in equal instalments over the loan period, or one lump sum at the end. | By depositing cash into the bank account during the year to reduce the amount overdrawn. |
| How is it recorded? | In its own Bank loan account (credited when the loan is taken). | As a credit balance in the Cash at bank account — there is no separate account. |
| How is it presented? | Under non-current liabilities as Long-term borrowings (the current portion sits under current liabilities). | Under current liabilities as Bank overdraft. |
"Long-term" = owed for more than one year. Each year-end, split off the part due within the next 12 months and call it the current portion of long-term borrowings — it moves to current liabilities. A loan is a fixed amount you borrow; an overdraft is spending more than you have in the bank.
Leaving the whole loan under non-current liabilities. At year-end, the part repayable within the next financial year must be split out as the current portion of long-term borrowings (a current liability). Only the rest stays under non-current liabilities.
Treating a bank overdraft as a long-term borrowing. An overdraft is a current liability (Bank overdraft) — it is repaid within the year, not over several years.
Forgetting that interest is a separate cost. The loan amount and the interest charged on it are recorded in two different accounts — do not add the interest into the loan balance.