3.5.3 Sources of finance

• Sources of finance are how businesses get money to finance growth, to overcome working capital / cash flow problems etc.
• Choosing the right source of finance

  • Consider a number of factors
  • External sources are more expensive
  • Retained profits require shareholder agreement
  • Depends on time period and purpose
• Key questions for managers

  How much finance is needed - Whether it can be obtained internally, whether it should be borrowed temporarily or obtained as permanent capital and the loan duration (short, medium, long term)
• The amount and nature of finance varies from firm to firm
• Factors influencing finance sources

  • Firm’s size
  • Form of ownership
  • Type of technology
  • Relationship between capital and labour
  • Length of credit periods
  • Age of the firm’s assets
• Internal Sources - Retained Profit

  Cheap and flexible<|>Technically profit is shareholders so they need convincing<|>Used to generate future profits<|>Opportunity cost needs to be assessed
• Internal Sources - Control of working capital and cashflow

  Working capital measures day-to-day expenses<|>Working capital = current assets – current liabilities<|>Need to manage liquidity<|>Stock needs to be valued correctly<|>Avoid holding excess stocks or cash
• Internal Sources - Sales of Assets

  Can develop more profitable ventures<|>Selling fixed assets can decrease long-term profitability<|>Should allow a firm to increase its level of profit
• Internal Sources - Sale and Leaseback

  Receive cash payment improving short-term cash flow<|>Have to rent the asset which may reduce long-term profit<|>Cash can be used to buy more profitable assets
• External Sources of Finance – Long Term

  • Share Capital
  • Loan Capital
• Share Capital

  Limited companies can issue shares<|>Shareholders receive dividends
• Types of shares

  • Preference shares
  • Ordinary shares
• Loan Capital

  Providers of loans are creditors
• Main types of loan capital

  • Debentures
  • Mortgages
  • Government assistance
• Debentures

  Long-term loan at fixed % interest repayable on a stated date
• Mortgages


  Used to purchase property
• External Sources of Finance – Medium Term

  • Bank loans
  • Leasing
  • Hire purchase
• External Sources of Finance – Short Term

  • Bank overdrafts
  • Trade credit
  • Debt factoring
• Bank overdrafts

  Agreed limit, stated time period
• Trade credit


  Suppliers allow time period before money is due
• Debt factoring

  Business receives immediate payment for credit sales
• Venture capital is money invested in a business, usually a start-up, that is seen as having strong growth potential. It is typically provided by investors who expect to receive a high return on their investment.
• What are some benefits of venture capital?

  No repayment

  Investors have experience
• What are some drawbacks of venture capital?

  Loose some control

  May fall out with investors

  Can be expensive and time consuming from investors point of view
• Debenture is a form of bind or long term loan which is issued by the company, usually with a fixed rate of interest
• What are some benefits of debenture?

  No control lost

  Issued by the company

  Fixed interest rate
• What are some disadvantages of debentures?

  Have to make regular repayments

  Loan usually secured against the assets of the company

  10 years + loan
• Debt factoring is a banking service which pays a firm a percentage normally around 90% of outstanding debts to improve a firms cash flow
• What are some benefits of debt factoring?

  Improves cashflow as the business gets cash faster

  Less likely to need an overdraft

  Debt factors collects the money for you
• What are some drawbacks of debt factoring?

  The debt factors keep about 5% of your debt

  Only around 80% paid upfront

  Can't do it if businesses has no receivables
• What are some examples of internal sources?

  Owners funds

  Retained profits - 60% of finance come from this source

  Sale of assets and possibly lease back
• What are some examples of external sources?

  Bank loan/mortgages/debentures

  Bank overdraft

  Debt factoring

  Venture capital

  Share/equity capital

  Crowd funding
• A business usually has to decide between:

  Share capital

  • Amounts invested by the shareholders it comprises of share capital and retained profits

  Loan capital

  • Finance provided to the business by external parties and includes bank loans, mortgages and debentures
• Share capital:

  1. company issues new shares
  2. Shareholders buy the new shares
  3. Company has more cash and more shareholders but less control
• What are some benefits of issuing shares?

  • Able to raise substantial funds if the business has good prospects
  • Equity rather than debt therefore a lower risk finance structure
• What are some drawbacks of issuing share?

  • Can be costly and time consuming (particularly floatation's for PLCs)
  • Existing shareholders holding may be diluted of they don't take up their rights to but shares
• What are different types of loans?


  Bank overdraft

  Bank loans

  Debentures

  Venture capitalists
• What happens when interest rates rise?

  Demand for products on trade credit may fall

  Costs of servicing existing loans may increase

  Cost of imported products may fall
• What happens when interest rates fall?


  Costs of imported products may rise

  Demand for products bought on credit may increase

  Costs of servicing existing loans may decrease
• Bank overdrafts

  • Short term finance, widely used by businesses of all sizes
  • An overdraft is really a loan facility - the bank lets the business ''owe it money'' when the bank balance goes below zero, in return for charging a high rate of interest
  • A flexible source of finance in the sense that is only used when needed