Chapter 25-Source of Finance

Quote
Start where you are Use what
you have Do what you can –
Arthur Ashe
 Learning objectives
 Explain the need for finance: short-term needs,
long-term needs, and to start up or expand.
 Discuss internal sources of finance: Personal
savings, retained profit and selling assets.
 Assess external sources of finance: overdraft
and trade payables, loan capital, share capital,
including stock market floatation(Public limited
companies), venture capital and crowd funding
 The need for
Funds
1. Short-term needs
This is money that can be used to meet the day-to-day running costs of the
business, such as wages, raw materials, components, and premises and utility bills
The finance needed to fund day-to-day expenditure is usually called short-term
finance; this is because it is usually repaid within one year.
2. Long-term needs
Long-term finance is the money borrowed for than one yeare.g. loanns from
financial institution such as banks. Some long-term finance comes from the owners
this called capital
It is used to finance/buy resources used repeatedly by the business for long periods
of time e.g. machinery, tools, equipment, property and office furniture.
3.Start-up cost
Funds are most needed first setting a business. This is because a lot of resources
are needed before trading can begin. Some of the resources are one off item.For
example, legal fees, website design, furniture etc.
4. Expansion
Once a business is established, the owners often want to expand.
They may want to: Expand capacity to meet growing orders, develop new products
& branch into overseas markets
 Internal Sources
Internal sources of finance
Internal finance is finance generated by business from its own means
Examples:
Personal savings
Retained profit
Selling assets

1. Personal savings
Entrepreneurs might use redundancy moey, loans or gifts from relatives and friends, the
sale of personal belongings or personal savings.

2. Retained profit
Retained profit held by a business rather than returning it to the owners and which may be
used in the future.
Advantages
Its cheap as no charges involved such as interest, dividends or administration
Its a flexible source of finance as it can be kept in a bank to earn interest and used later
Disadvantages
Some owners might object it as it cannot be returned to the owners.
 Internal Sources

3. Disposal Of Assets/selling asset or (Sale & Leaseback)

• Selling non-current assets (not needed) like spare land/buildings & equipment creates a
one off cash inflow
• Sale and leaseback raises cash from the sale of fixed assets then leasing them back from
the new owner

Advantages of internal sources

The capital is available immediately
internal finance is cheap
The business will not be subject to credit checks
Disadvantages of internal sources
Internal finance can be limited
opportunity cost of using internal sources of finance can be high
 -
External Short-term sources

External sources of finance

External finance is finance obtained from the otuside the business.
 The are both short-term and long-term finance external sources of finance.
Reasons to use short-term sources
Some businesses have seasonal trade
a manufacturer may need finance to pay raw materials and wages to meet a large order
A firm might be short of money because it is waiting for a customer to pay
A business may need to meet emergency expenditure
Main sources of short-term finance: Bank overdraft, Trade payables & Credit cards

1. Bank overdraft
Bank overdraft is an agreement with a bank where a business spends more money than it
has in its account (up to an agreed limit)
Advantage
They are simple and flexible
Interest only paid on the amount overdrawn
Disadvantage
 Short notice for repayment at any time
 Very high interest rate
 -
External Short-term sources

2. Trade payables
Trade payables is buying resources from supppliers, such as raw materials and
components, and paying for them at later date (sometimes called trade credit) usially within
30 to 90 days.
Advantages
It is a cheap way of raising finance
Disadvantages
Many suppliers encourage early payment by offering discounts
the cost of goods is often higher if firms buy on credit
delaying payment may upset suppliers
3. Credit cards
Advantages
They are convenient, flexible and avoid interests charges if accounts are settled
within credit period
Disadvantages
interests charges are very high if accounts are not settled within credit period,
usually 56 days.
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External Long-term sources

1. Loan Capital
 A loan is a fixed agreement between a business and the bank. The amount
borrowed, and interest, must be repaid in regular instalments over a fixed period.
Bank loans can be short-term or long-term soruces of finance.
back overdrafts, band loans, debentures
Advantages
 greater certainty of funding, if the terms are complied with
Disadvantages
 It requires security
2. Unsecured loan
Unsecured loans means that the bank lends money without security of having
claim on your assets if you do not pay it back.
Disadvantage
Interest rates are higher for unsecured loans compared to secured loans
3. Mortgages
A mortgage is a long-term loan and borrower must use land or property as
security. This means that if the borrower fails to make repayments the lender can
reposses the property.
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External Long-term sources

4. Debenture
Debenture is a long-term security yielding a fixed rate of interest issued by a
company and secured against assets
Public limited companies (PLCs) use this long-term source of finance.
5. Hire purchase
Hire purchase is buying specific goods with a loan, often provided by a finance
house.
Features of HP agreement
the business usually makes a down payment
the remaining fee is paid in monthly instalments
the goods bought do not legally belong to the buyer until the very best last
instalments has been paid.
if the buyer falls behind with the repayments, the goods can be repossed
HP agreements can be short term or long term
Disadvantage
Usually more expensive than a bank loan.
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External Long-term sources

6. Share capital
Flotation – new issue of shares
• Stock market flotation raises new capital by selling a percentage of a company
on a stock market for the first time
• Allow existing shareholders to achieve a full/partial disposal of their investments
• Base of the company becomes much wider
Rights Issue
• Raise more capital
• Company issue new shares, offering them first to existing shareholders
• Shares in a rights issue will be offered at a significant discount to the current
market price, especially if the shareholders for those shares are really needed
Main advantage
The interest payments are avoided
Huge sum of money can be raised
Main disadvantage
Shareholders expect to paid dividends if the business is successful
Issuing shares to raise capital has high cost of administration
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External Long-term sources

7. Venture capital
Venture capitalists are specialists investors (individuals or companies) who
provide money for business purposes, often to new businesses.They raise
their funds through institutional investors e.g. pension funds, insurance
companies and wealthy individuals
They may invest in businesses after the initial start-p and often prefer
technology companies with a high growth.
They prefer to take a stake in the company, which means they have some
control and entitled to share in the profit.
Some venture capitalists are individuals and may be called business angels.
Advantages
 Benefits from specialist investor support
 Helps original owners realise their investment
Disadvantages
 Not long term, venture capitalist exit after between 5-7years
 Dilutes the control as they want a stake
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External Long-term sources

8. Crowd funding
Crowd funding is where a large number of individuals (the crowd) invest in a
business venture using an online platform and therefore avoiding using a bank

Homework after preview -Past paper Booklet

Page 31 Question 4 (a) (i) & (ii)
Page 54 Question 1 (c) (i) & (ii)
Page 107 Question 2(c) (i) & (ii)