Borrowed funds

What it means

Borrowed funds are the part of liabilities and equity provided by someone other than the owners. They include payables to suppliers, employees, the state and insurers, bank loans and other borrowings, provisions and deferred income. Together with equity they make up the whole right-hand side of the balance sheet.

The key difference from equity is the duty to repay. A supplier must be paid by the due date, a bank in instalments with interest. The company owes the owner no repayment; it can only share its profit with them.

On the balance sheet borrowed funds are split into long-term and short-term according to the remaining time to maturity. Short-term items are compared with current assets to give liquidity ratios. Their share of the total shows leverage.

How it works in practice

When assessing a loan, banks look at the structure of borrowed funds: how much is bank debt, how much is overdue and whether long-term assets are being financed with short-term money. When preparing documents for a bank, we therefore adjust the breakdown so it reflects reality.

Loans from shareholders are a category of their own. For the bank they are borrowed funds, but if they are subordinated to the bank loan, the bank may treat them almost as equity. With related parties the thin capitalisation rules on interest must also be watched.

The mix of equity and borrowed funds is a decision about capital structure. Borrowed money is usually cheaper, since interest is deductible, but it raises risk. A company with too much debt loses room to manoeuvre at the first dip in sales.

What to watch out for

A common mistake is failing to report all borrowed funds. Missing uninvoiced supplies, unbooked holiday provisions or unrecorded amounts owed to the director flatter the company in a way that then fails at an audit or in due diligence.

It is equally risky when borrowed funds exceed the value of the assets. That signals over-indebtedness, and the director must consider their duties under the Bankruptcy Act. A regular look at the balance sheet reveals such a situation before it is too late.