2.1-Raising finance

• What are the sources of finance?

  This refers to where a business gets its money from for spending on various items.

  The items this money is needed for can be split into two main categories:

  • Revenue expenditure (day to day) e.g. stock, wages, rent, etc.
  • Capital expenditure (non-current assets) e.g. machinery, premises, vehicles, etc.
• Why is finance needed?

  • Starting a business- there will be a need to buy FOPs and premises to produce goods. This is generally before any revenue has bee generated so arranging funds to pay for these is crucial.
  • Growing a business- expansion is expensive. Profit may be used but additional sources may need to be accessed
  • Other situations- a slow sales period, giving customers credit, etc. can lead to cash flow problems so a business may need to find additional funds
• Internal sources of finance- owners capital


  This is the money the owner invests in the business. The owner may have used savings to start up the business. Likely to be used by sole traders/ partnerships as small businesses don’t need huge sums of money.

  🤑 Not borrowing from anyone, not getting into debt

  😢 May not have enough capital needed

  😢 Opportunity cost of using the cash elsewhere/ keeping It for the owners
• Internal sources of finance - retained profit


  After a year or more of trading a business may have some profits that they are able to reinvest into the business to help It grow. The owner may decide to keep it in the business to fund expansion rather than take it for themselves. 😎Not borrowing from anyone, not getting into debt. 😵 May not have enough profit needed. 😵 The opportunity cost of using the profit elsewhere/ keeping it for the owners
• Internal sources of finance- sale of assets 


  A business can raise finance by selling items they already own

  😁 Not borrowing from anyone, not getting into debt

  😫 May realise they need the assets later on

  😫 May not have spare assets to sell

  😫 May not get the required amount needed
• External sources of finance- family and friends


  A sole trader or partnership may find that their family may want to contribute to the business. This may be for interest, a share of the profit or just to help out.

  😂 No need to borrow from a bank or sell assets

  😔 may not have enough capital needed

  😔 may have to repay or give a share of the business

  😔 depends on the conditions from F&F
• External sources of finance- banks


  Banks may lend money to a business to start-up or for growth. Banks may also provide a business with an overdraft to help when they experience cash flow problems or mortgages to purchase premises.

  😋 No need to sell assets

  😋 Useful if the business doesn’t have enough retained profit

  😋 May be able to get a large amount

  🙄 Have to repay + interest

  🙄 Banks may not be willing to lend to lend the required amount
• External sources of finance- peer to peer funding (P2P)


  Individuals lend money to businesses. Managed by an intermediary company. Lenders choose how much they wish to lend and the interest they want to earn then they are matched to businesses.

  😝 Could access large amounts of cash

  😝 No need to sell assets

  😝 Useful if the business doesn’t have enough retained profit

  😵 May not get the amount needed

  😵 Have to disclose what it’s for

  😵 Have to repay + interest

  😵 Not always suitable for new/ small businesses
• External sources of finance- business angels


  Wealthy individuals who invest money into new or innovative businesses that they think have the potential to be successful. The investor would normally take shares in your business in return for finance. In doing so, they normally speak to not only provide your business with the money to grow, but also bring their experience and knowledge to help your company achieve success.

  🤭 Get the cash and also experience and advice

  😶 Usually have to give away shares of the business

  😶 Loss of control
• External sources of finance- crowdfunding 


  A large number of people fund a project over the internet making small investments each. They can either: Donate, lend or invest

  😍 May not need to repay

  😍 Could raise large amounts of cash

  🫨 Have to disclose ideas which could get capital

  🫨 May not raise enough

  🫨 May have to pay back or give a share of the business
• External sources of finance- other businesses


  Some businesses with a large retained profit may wish to invest in another business rather than save profits. They may want to do this when interest rates are low. They may invest in a business that can aid its own success. 😁 May get help/advice from other businesses.

  😁 Avoids having to sell assets

  😁 Useful if the business has limited retained profits

  🫠 May be quite a rare opportunity

  🫠 Need to repay cash plus interest
• Methods of finance- loans


  Organisations will lend to small businesses but may not lend when they first start up as there is no track record or history of them making money. A lender will want to see a business plan so they know how their money will be paid back.

  😝 No need to sell assets

  😝 Useful if the business doesn’t have enough retained profit

  😝 May be able to get a large amount

  😢 Have to repay with interest

  😢 Lender may not be willing to lend the required amount
• Methods of finance- share capital 


  In a PLC they can raise more finance by having an ordinary share issue. This is an external and long term method of finance but would only apply to a large business with a PLC after its name 🥰 Don’t have to repay

  🥰 May be able to get a large amount

  😫 Have to give away shares in the business

  😫 Losing control

  😫 Will have to pay dividends
• Methods of finance- venture capital 


  This is used for businesses that are high risk but have potential to be successful. VC can be provided by business angels. The BA will look for a strong business plan, good management and a proven track record, making it difficult for start-up firms

  😅 Get the cash and also experience and advice

  😬 Usually have to give away a share of the business

  😬 Loss of control
• Methods of finance- overdrafts


  An overdraft is when a bank allows a business to have a negative bank balance. An overdraft may be organised by the bank which is short term lending of smaller amounts of money. If the business goes over this amount the overdraft will be unauthorised and the business will be charged heavily.

  ❤️ No need to sell assets

  ❤️ Useful when experiencing cash flow problems

  💔 Have to repay with high interest

  💔 Penalties for going over the agreed amount
• Methods of finance- leasing


  As a business grows it may decide that it needs some more vehicles or equipment but may not have enough money to buy them. They may decide to lease the equipment by paying monthly. They will never own the equipment but will get the option to change it when the lease period ends.

  😇 Better for cash flow rather than paying in full to purchase the asset

  ☹️ Will never own the asset and will have monthly outgoings
• Methods of finance- trade credit

  When one business trades with another they will sometimes need to buy goods with trade credit. The seller gives the buyer a certain amount of days to pay. The buyer then has time to sell the goods in their own shop before they have to pay for them.

  🤩 Positive for cash flow

  😒 May damage relationship with suppliers

  😒 May just push financial pressures later into the year
• Subsidies


  A fixed sum of money given to a business by a government. Can also be from other organisations not just the government like charities.

  😝 Do not need to repay

  😝 No loss of control

  😔 Rare opportunity and only available for certain businesses and industries
• Finance appropriate for unlimited liability businesses

  • More likely to rely on sources of finance that don’t involve someone becoming a part owner
  • Legally these businesses can’t use share capital
  • May be more favourable with suppliers and banks as there would be a good chance they get their money back because owners would have to sell everything they own to pay back the debts
• Finance appropriate for limited liability businesses

  • Can legally raise funds from share capital so is a method they can use that is not available to unlimited liability
  • May be easier to encourage business angels and other businesses to invest due to protection of limited liability
  • Even though many limited liability businesses maybe larger and deemed lower risk, banks and suppliers may be wary of lending to them as they may not get all the money repaid
• Other influences in sources of finance- cost

  • Interest rates- when interest rates are low, this could make taking out loans more attractive
  • Cost of selling shares- A share issue can be an expensive method of raising capital due to administration, promotion and expertise of organisations to organise the sale
  • Opportunity cost- using one source may have a cost in terms of what has to be given up as a consequence of the decision
• Other influences on decisions on source of finance- flexibility 


  Some resources are highly flexible and can be adapted to meet a business’ precise needs. For example, an overdraft
• Other influences on decisions on sources of finance- control


  Some resources may result in the original owners of the business losing some, or even complete control. For example, sale of shares
• Other influences on decisions on sources of finance- the purpose for which the finance is needed

  • Some sources are suitable in certain situations e.g. finance to purchase property and has to rely on loan finance will probably consider taking out a mortgage
  • If the finance is being raised to fund a risky startup then venture capital may be the best choice.
• A good business plan can:

  • Prove the entrepreneur has done their research and convinces potential investors everything has been well thought through
  • Show that there are low risks if the business failing
  • Show how profitable the business expects to be and when potential investors should start to see returns on their investment
  • Provide a clear description of the product and people involved in the business- this can help convince investors the entrepreneur believes in the product, are passionate and have the drive to succeed
• Specialist business terminology

  • Overtrading- a business expands too quickly without having the necessary financial resources
  • Working capital- capital for day to day spending
  • Debt factoring- a business sells its invoices (receivables) to a debt factoring company to receive instant cash
  • Payables- money the business has to pay
  • Receivables- money the business is due to receive
• Specialist business terminology part 2

  • Insolvency- when a business can’t pay its debts and leads to bankruptcy and business closure
  • Trade credit- buy now, pay later
  • Dynamic market- fast growing and changing
  • Overdraft- an agreement with the bank to use more money that is available in the bank account, to pay back later with interest (method of finance)
• What are cash flow forecasts?


  Cash flow is the movement of cash into and out of a business in a given time period. CFF state the inflows and outflows of cash that the manager of a business expects over some future period
• Benefits/ purpose of CFF

  • Identification of cash shortages- the CFF will show if there is sufficient cash available each month.
  • Comparison of actual cash flow with forecasted cash flows- inflows and outflows can be monitored against the forecast, allowing differences to be identified and investigated, using variance analysis. Plans can then be altered and solutions to possible problems considered. This should allow the business to keep tight control over cash flow.
  • Supports application for finance
• Causes of cash flow problems

  • Over trading- firms that are expanding rapidly are particularly likely to experience cash flow problems.
  • Allowing too much credit or too long credit period
  • Poor credit control- amount of money tied up could increase. This may mean that inflows may be delayed, increasing the chance for cash shortage
  • Inaccurate CFF
• How are cash flow forecasts calculated?

  • Net cash flows = inflows - outflows
  • Opening balance= closing balance from previous month
  • Closing balance= net cash flows + opening balance
• Analysing CFF- net monthly cash flow and closing balance

  • A business wants to have a positive net monthly cash flow. A negative net monthly cash flow can cause problems for a business if it doesn’t have sufficient cash to cover it
  • A negative net monthly cash flow for a sustained period of time can lead to negative closing balances which could cause a business to become bankrupt (or insolvent)
• Analysing CFF- payables and receivables

  • Payables is a term that relates to the amount of time taken by a business to pay its suppliers and other creditors
  • Receivables relates to the time taken by a business’ customers to pay a business for their product
  • One useful way of analysing a business’ cash flow position is to compare the number of days for payables and receivables. If the figure for receivables is higher, this could cause the business to experience cash flow problems
• Analysing CFF- identifying potential crises

  One important aspect of analysing cash flow forecasts is to highlight when the business may be short of cash. This allows managers to make appropriate decisions to avoid the problem and may prevent some vulnerable businesses from failing.
• Improving cash flow- improved control of working capital


  Working capital is the finance available to the business for its day to day activities. This is available to a business when its customers pay for the good or service they have received
• Improving cash flow- improved control of working capital (negotiate improved terms for trade credit)


  Firms may be able to negotiate trade credit with suppliers. This will improve the firms cash position by delaying payments.
• Improving cash flow- improved control of working capital (offer less trade credit to customers)


  A business can help its cash flow position by offering customers less favourable terms for trade credit to reduce time of receivables.
• Improving cash flow- debt factoring


  A firm can receive cash earlier by ‘selling’ its customer debts (receivables) to a debt factoring company, they will then chase the debts themselves and the business benefits from getting the majority of the money immediately, rather than waiting for the full amount
• Improving cash flow- arrange short term borrowing 


  A loan for example, provides cash to cover short-term shortages at rates of interest lower than that on an overdraft. However, it is less flexible and a business must make repayments plus interest increasing cash outflows.
• Improving cash flow- sale and leaseback


  If a business owns a fixed asset it may be possible to sell the asset to a finance company and then lease it back. This raises a large amount of cash quickly but means that a business loses possession of the asset. This extra cash may allow a business to expand or make it through a difficult period of trading. However, a business then has to allow for a long-term expense and no longer would be able to use the asset to secure future finance.