Sources of Finance

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Sources of Finance
GCSE Business Studies
tutor2u
Revision Presentations 2004
2
Reasons a Business Needs Finance

• Start a business
• Finance new technology
• Open new markets
• Acquisitions
• Moving to new premises
• Day to day running of business

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Internal and External Sources

• Internal Sources of Finance
• Come from trading of business
• Day to day cash from sales to customers
• Money loaned from trade suppliers through
  extended credit
• Reductions in amount of stock held by business
• Disposal (sale) of any surplus assets no longer
  needed (e.g. selling a company car)
• External finance
• Comes from individuals or organisations who do
  not trade directly with business
• E.g. banks, investors. government

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Short and Long-term Finance

• Short term finance
• Needed to cover day to day running of business
• Paid back in a short period of time, so less
  risky for lenders
• Long term finance
• Tends to be spent on large projects which will
  pay back over a longer period of time
• More risky so lenders tend to ask for some form
  of insurance or security if company is unable to
  repay loan.
• A mortgage is an example of secured long-term
  finance

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Main Sources of Long-term Finance

• Mortgages
• Bank loans
• Share issues
• Debentures

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Criteria for Choosing a Source of Finance

• Amount of money required
• How quickly money is needed
• Cheapest option available
• Amount of risk involved in reason for cash

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Using Own Cash to Start a Business

• Own cash is cheapest form of finance since it
  carries no obligation to pay any interest
• Dont need to give any control of business to any
  other party
• More flexible than other sources
• No authorisation hurdles to overcome
• Can add more finance if required (and available)
• Various tax incentives for people who invest in
  their own business

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Sources of Finance for Sole Traders and
Partnerships

• Bank loans
• Bank overdraft
• Trade credit
• Retained profits
• Taking on a new partner
• Government grants (depending on area and
  activities
• Remember there is no company so a sole trader
  or partnership cannot have shareholders providing
  finance

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Share Issues

• Two types of limited company that define the way
  that money can be raised through shares.
• A private limited company can sell shares only to
  designated people and there is a limit how much
  capital they can raise through this method
• A public limited company can issue shares to the
  public. This means anyone can have a share in
  the company
• Finance raised by a company by selling new shares
  to shareholders
• Unlike a loan money does not have to be repaid
  over a fixed period of time
• Note when one shareholder sells shares to
  another, the company does not raise any
  additional funds since no new shares have been
  issued

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Ordinary Shares and Preference Shares

• Ordinary shares
• The most common form of share capital
• Ordinary shareholders can vote at company
  meetings
• Amount of dividend received varies
• Preference shares
• Shareholders do not have a vote at company
  meetings
• Dividend is usually fixed (e.g. 5 of value of
  shares held paid as dividend each year)
• Shareholders receive their dividend before
  ordinary shareholders

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Return on Investment for Ordinary Shareholders

• Comes in two parts
• Dividends - paid out on each share held by
  company
• Increases in value of each share as company
  itself grows in value (capital gain)
• Note 1 a shareholder only actually realises a
  gain on the increased value of a shareholding
  when those shares are sold. Otherwise it is just
  a gain on paper
• Note 2 Companies do not have to pay out
  dividends
• There may be no profit available (dividends can
  only be paid out of profits)
• The shareholders may wish to reinvest profits in
  the business rather than take cash out

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Debentures

• Source of long term finance
• In the form of a loan
• Usually secured against an asset
• Repayable at a fixed date
• Fixed rate of interest

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Difference between Debentures and Ordinary Shares

• Lender has no voting rights in company
• Loan attracts interests whereas holders of
  ordinary shares get dividends
• Providers of loans are paid out before ordinary
  shareholders in event that business fails
  (assuming there is some cash left)

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Finance Available from a Bank

• Bank overdraft
• Bank loans
• Asset finance (leasing)

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Bank Overdrafts and Bank Loans

• Bank overdraft
• Limit on borrowing on a bank current account
• Amount of borrowing may vary on a daily basis
• Technically repayable on demand by the bank
• Bank loan
• Fixed amount for a fixed term
• Regular fixed repayments
• Interest on a loan tends to be lower than an
  overdraft
• Normally a fixed term loan will be for a greater
  amount than an overdraft

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Working Capital

• Amount of short term capital available for day to
  day running of business
• Expressed as current assets less current
  liabilities e.g. value of debtors and stocks less
  creditors
• Working capital normally needs to be funded
• E.g. the value of stocks and trade debtors is
  more than the value of trade creditors

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Debt Factoring

• Business sells its outstanding customer accounts
  (those who have not paid their debts to business)
  to a debt factoring company
• Factoring company pays business face value of
  debts less a charge (e.g. 15-20), but then
  collects full amount of debts for itself
• Good way of raising cash quickly, without hassle
  of chasing payments
• BUT not so good for profits since it reduces
  total revenue received from those sales

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Government Grant Funding

• Protect jobs in failing/declining industries
• Help create jobs in areas of high unemployment
• Help start up new businesses
• Help businesses relocate to areas of high
  unemployment
• Examples
• European Structural Fund
• Assisted Areas
• Regional Selective Assistance

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Leasing

• What is involves
• Like renting a piece of machinery/equipment
• Business pays a regular amount for a period of
  time
• Items belong to leasing company
• Advantages
• Cheaper in short run than buying a piece of
  equipment outright
• If technology is changing quickly or equipment
  wears out quickly it can be regularly updated or
  replaced
• Cash flow management easier because of regular
  payments
• Disadvantages
• More expensive in long run, because leasing
  company charges fees which make total cost
  greater than original cost

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Hire Purchase

• Business hires equipment for a period of time
  making fixed regular payments
• Once payments have finished it then owns piece of
  equipment
• Different to leasing in that business owns
  equipment when it has finished making payments

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Sources of Finance for Public Sector Businesses

• Tax revenue from government, usually paid out in
  form of grants or subsidies
• Fees paid by public or businesses e.g. trading
  licences
• E.g. In case of BBC, money from TV licence