9. Sources of finance

• Internal/equity finance is finance that can be obtained within the business and carries no additional costs to the business
• Internal sources of finance:

  • Owners Capital
  • Retained profits
  • Sale of business assets
• Owners capital can come from many sources such as: savings, redundancies, inheritances
• Retained profits are the profits that the business has made previously and is keeping in reserve
• Sale of business assets is the process of selling assets that are no longer used by the business
• Owners capital is primarily used as start-up finance for sole traders and partnerships
• Owners capital can be beneficial as it doesn't have any debt or cashflow issues and doesn't attract interest payments
• A drawback of owners capital is that it has unlimited liability and owners can lose their investments
• Retained profits are used for growth and expansion strategies
• Retained profits can be beneficial as they don't have repayments and do not attract interest payments
• A draw back of retained profits is that it only applies to existing businesses and they may not have retained enough profits
• Sales of business assets is used to increase cash injections quickly for current bills and day-to-day running of the business
• Sales of business assets can be beneficial as it raises finance quickly without requiring debt and interest charges
• A draw back of sales of business assets is that very few businesses have assets to sell that wouldn't affect their trading
• External/debt finance is finance that can be obtained from sources outside the business, and generally carries additional costs
• Examples of short term external finance:

  • Bank overdrafts
  • Bank loans
  • Hire purchase
  • Leasing
  • Trade credit
• Bank overdrafts provide short term temporary finance to assist in the day-to-day running of the business
• Bank overdrafts can be beneficial as banks are more receptive to overdrafts as they are short term and confined to certain amount and time period
• One drawback of bank overdrafts is that they occur higher interest rates than normal loans and large penalty charges if the overdraft is not repaid.
• Banks loans is an amount of money loaned by the bank with an agreed interest rate and specified monthly repayments for the full period of the loan agreement
• Banks loans can be beneficial as they allow the business to keep its ownership and control whilst the loan is being repaid. They also have a fixed interest rate which is not subject to changing market interest rates
• Drawbacks of bank loans include high interest rates depending on risk and collateral, failure to repay loans is a liquidity problem and can cause businesses to fail
• Hire purchase is a finance loan by a lender which pays the full amount of a purchased asset to the retailer on the businesses behalf with the business repaying the full loan plus interest to the lender over an agreed period of time
• Hire purchase can be beneficial as it allows a business to purchase assets without having the full finance immediately to hand, they often have competitive interest rates and allow the business to scale faster
• A drawback of hire purchase is that the lender can repossess assets if monthly repayments cannot be met, along with this the value of the asset is likely to decrease over time with depreciation by the time the final payment is reached
• Leasing is similar to hire purchase however the main difference is that asset ownership is retained by the leasing company and it is returned to the leasing company at the end of the agreement
• Leasing can be beneficial as it allows a business to purchase assets without having the full finance immediately to hand, the business can lease the asset until it is no longer required as they never own it, allowing for it to be replaced and updated
• A drawback of leasing is that the asset can become very expensive in the long term compared to hire purchase or buying it outright
• Trade credit is when suppliers allow their customers additional time to pay for goods to help with cashflow
• Trade credit can be beneficial as the business has the opportunity to sell inventory and receive money prior to paying the supplier which aids cashflow
• A drawback of trade credit is that the supplier can renew trade credit agreements and reduce the time period causing cash flow problems
• Examples of sources of medium term external finance are:

  • Factoring
  • Sale and lease back
  • Venture Capitalists
• Factoring is when the business sells its monthly trade receivables invoice to a factoring company which pays the full amount minus its fees and commissions, before the invoice is payable. The debtor pays the sold invoice amount in full to the factoring company at the end of the month
• Factoring can be beneficial as the business doesn't have to wait 30 days for trade sales invoice to be paid which improves cash flow as the business receives money at least 30 days earlier than expected
• A drawback of factoring is the business does not receive the full amount from the lender as they charge commission or a fee for factoring and the company can require the full amount be repaid if they have difficulty collecting from the debtor
• Sale and leaseback is when the business sells an asset for the full value and rents or leases it back from the new owner
• The sale and leaseback of assets can be beneficial to a business as it realises major funds allowing the business to expand and grow with no major repayments of interest collected
• A drawback of sale and leaseback is that rent / leaseback are now payable is that rent/ leasing fees are now payable to the new owner and they can increase this at any rent / leasing review
• Venture capitalist finance is when a venture capitalist company provides finance to a business in return for an agreed shareholding in the business
• Venture capitalist finance can be beneficial as the company is also a shareholder who will be striving to increase company profits and dividends as a result of the value of the company and share price will increase