sources of finance

• what is the definition of internal sources of finance ?

  Money that is generated from within the business or from the business owners own capital:

  • Reinvested profits
  • Squeezed out of working capital
  • Sale of assets
  • Owners savings
• what is the definition of external sources of finance ?

  Money that is raised from sources outside of the business.
• advantages of retained profit / own funds (internal source ) ?

  • Cheapest form of finance as you do not have to pay interest on own money
  • Immediately available
  • This will provide a liquidity buffer and potential funds for growth
• disadvantages of retained profit / own funds (internal source ) ?

  • Money is tied up in business so not earning interest
  • Cannot use for other purposes (opportunity cost)
  • Reserves, reinvested profits, come with only one cost – the loss of profit distribution to owners.
  • Short-term pressures to pay profits to owners (normally shareholders) can, however, restrict the availability of this form of finance
• advantages of retained working capital (internal source ) ?

  • By reducing their trade credit period and collecting debts more efficiently, a business may receive money from customers more quickly.
  • Reducing stock holdings is another way to release finance …
• disadvantages of retained working capital (internal source ) ?

  • this is likely to drive customers away and may have the opposite effect on making finance available
  • but a sudden surge in demand could result in lost sales if the business is unable to meet delivery dates
• advantages of sale of assets (internal source ) ?

  Established businesses are able to sell off assets that are no longer required, such as buildings and machinery
• disadvantages of sale of assets (internal source ) ?

  Smaller businesses are unlikely to have such unwanted assets and, if growth is an objective, they are much more likely to want

  to acquire assets as opposed to losing them
• definition of bank loans ( external )?

  A loan is borrowing a fixed amount, for a fixed period of time, perhaps 3–5 years
• advantages of bank loans (external ) ?

  • If application for the loan is successful the money becomes immediately available
  • Payments made up of interest and capital are made monthly which can help with cash flow planning
  • Funds made available for medium to long-term borrowing of large sums of money hence suitable for example if a business needs to acquire building land
  • Offering security against a loan can make it much easier to get funding and reduces interest rates charged
• disadvantages of bank loans (external ) ?

  • Interest has to be paid on the loan – thus businesses have to pay back more than what they borrowed
  • Very difficult to obtain for small businesses – it is likely that most new start-up’s are unlikely to receive a loan unless security is offered
  • Some form of collateral may be required to secure the loan – if the business owner is not able to maintain payments, homes can be lost or business assets removed
• definition of an overdraft (external ) ?

  An overdraft is the facility to withdraw more from an account

  than is in the bank account, resulting in a negative balance
• advantages of overdraft ( external ) ?

  Very useful for overcoming short term liquidity problems – useful for day to day transactions, easing cash flow needs and emergency requirements Only pay interest when account is overdrawn i.e. do not have to pay off regular sums
• disadvantages of overdraft ( external ) ?

  • Interest charged can be very high indeed
  • The overdraft limit tends to be fairly low for small businesses
  • May be arrangement fee
  • Can be called in immediately – it is repayable on demand
• definition of trade credit ?

  Businesses buy items such as fuel and raw material and pay

  for them at a later date
• advantages of an trade credit (external )?

  The 30-90 days offered by suppliers can be viewed as interest free way of raising finance
• disadvantages of an trade credit (external )?

  • Suppliers often offer discounts for cash or early payments, meaning the cost of goods is higher if full credit period is used
  • Late payment can also lead to a business gaining a bad reputation with suppliers
• what is the definition of factoring ?

  Factoring is a method of turning invoices into cash
• advantages of factoring (external )?

  • Banks and other places offer factoring services which pay a proportion of the value of an invoice (80–85%) when the invoice is issued. The balance, minus a fee, is paid to the business when the invoice is paid
  • This flexible form of finance keeps pace with business growth as the funding is directly linked to the turnover of the company
  • The factor will also undertake all credit management and collections work
  • The use of this service results in savings in administration costs, and faster customer payments means lower interest costs on any overdraft facility
• disadvantages of factoring (external )?

  Factoring services are only offered to businesses with a good trading record and reliable customers
• definition of leasing ?

  The company gains use of a productive asset, without ever

  owning it
• advantages of leasing (external )?

  • The business acquires the use of resources without the need for a large sum of money
  • The maintenance and repair bills are met by the leasing company
  • Leases are generally easier to obtain than loans
  • Equipment can be updated regularly
• disadvantages of leasing (external )?

  • Over a long period of time it can be a very expensive and well in excess of the purchase price
  • The business never gets to own the items leased
• definition of hire purchase ?

  Installment plan for purchasing capital goods where the buyer takes possession of the item upon payment of a deposit and agrees to pay the remaining balance in regular installments.
• advantages of hire purchase (external )?

  • Useful for purchasing plant and machinery which can be obtained quickly
  • Finance houses may also be less selective than banks
  • At the end of the hire purchase period the business will own the asset
• disadvantages of hire purchase (external )?

  • Interest rates are usually very high
  • The property is not owned by the business until the last payment has been made. Items can be legally repossessed if the business falls behind with repayments
  • Add servicing charges for paying in instalments
• definition of commercial mortgages ?

  If a business owns property a commercial mortgage may be

  available
• advantages of commercial mortgages (external )

  • the property is used as security against the loan and the loan can be as much as 60 or 70% of the value of
  • the property the interest rates will be lower than an unsecured loan, due to the security
  • Payments are made monthly for the term of the mortgage
  • may run for 10 or 15 years so generally have predictable costs – this can be helpful with budgeting and predicting cash flow
• disadvantage of commercial mortgages ?

  Failure to make repayments may lead to the property being

  repossessed by the lender
• definition of sale and leaseback ?

  This involves the business selling assets (buildings, machinery) to a finance company and then leasing the asset back
• advantages of sale and leaseback (external)?

  • This method of raising finance means that the capital that is produced can be reinvested into growing the business
  • An asset owned by the business can be turned into capital for reinvestment in the business
  • Sale and leaseback also carries potential tax benefits as the leasing costs are offset as an operating expense
• disadvantage of sale and leaseback (external)?

  Once the item has been sold it is no longer and asset of the business thus it is a one time option
• definition of share capital ?

  A long-term method of providing funds for growth is to sell shares.
• advantages of share capital (external ) ?

  • Share capital is a form of permanent capital; this means it does not have to be repaid
  • Owners of shares have a say in how the business is run, but the amount of influence they have depends upon the percentage shareholding they own
• disadvantages of share capital (external ) ?

  • Loss of control – the business owner or owners will have decisions influenced by new investors
  • New shareholder investors may be looking for an exit strategy within a few years. This means that they are expecting the business to grow rapidly and then they expect to be able to sell their shares, taking their capital gain
• definition of business angels/ venture capitalists

  Professional investors who can invest large amounts of

  capital into small and medium-sized businesses
• advantages of business angels/venture capitalists?

  • Possibly large sums of money can be attained quickly
  • Advice may also be given
• disadvantages of business angels/venture capitalists?

  Will not only take a shareholding but also expect to be fully involved in running the business
• definition of government grants / assistance

  Both local and central government may offer finance to

  business start-up schemes
• advantages government grants / assistance ?

  • Usually given to small businesses in regions where unemployment is high
  • Often they are grants which do not have to be repaid