Sources of Finance

• Internal sources of finance = internal sources are sources of money from within the business, from the owner, or from previous business income (earned through profit);
• External sources of finance= external sources are sources of money from outside the business, from other people putting money into the business.
• examples of internal sources of finance= Personal Savings / Owners’ Capital ; Retained profits ; Sales of assets.
• examples of external sources of finance (short term) = Overdraft ; Trade credit ; Hire purchase ; Leasing.
• examples of external sources of finance (long term)= Bank loan/ mortgage ; Loans/finance from family or friends ; Government assistance (Grants) ; Share capital/ issue ; Take on a partner ; Venture capital ; Business angels.
• Personal Savings / Owners’ Capital (internal)= Money that is put into a business by its owner or owners. Advantages • Not an inexpensive source of finance but requires no interest or repayments. Disadvantages • May not have the required amount, for example, expansion plans are likely to require a considerable sum of money.
• Retained profits (internal)= Profits that have been kept in the business rather than paid out to its owners. Advantages • Cheaper than taking out a loan. • Business has the flexibility to decide how much is used and when. Disadvantages • Once the money has been used it is gone. • Owners or shareholders may want the retained profit as their income.
• Sale of Assets (internal)= Items of property owned by the business that are sold to raise funds. Advantages • If the assets are no longer required, this could raise large sums of money. Disadvantages • All assets are likely to be essential to the business ➔ once sold they are no longer available for use.
• Overdraft (external)=A form of short-term loan provided by banks to cover cashflow difficulties of businesses. Advantages • The business is allowed to take more from its account than is in the account. • When cash is paid into the account, the overdraft will be cleared. Disadvantages • Interest is paid on overdrawn amount. • Counts as a current liability as the amount has to be paid back
• Trade Credit (external) =A system of interest free short-term credit for the purchase of non-durable goods. Advantages • Allowed credit for short time ➔ usually 30 days ➔ no interest charged ➔ discounts allowed if payment within time. • Allows products to be sold before payment. Disadvantages • Counts as a current liability as the amount has to be paid to the other business.
• Hire Purchase (external)=A system where goods are rented but which are eventually owned by the business. Advantages • Useful for purchasing plant and machinery which can be obtained quickly. • Finance houses may also be less selective than banks. • The good becomes the property of the buyer when the final payment is made. Disadvantages • 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.
• Leasing (external) =A system of renting an asset to a business. The asset remains the property of the company renting out the good. Advantages • 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. • They are generally easier to obtain than loans. Disadvantages • Over a long period of time it can be very expensive and well in excess of the purchase price. • The business never gets to own the items leased.
• Bank Loan/ Mortgage (external)=Long to medium term loans that can be used to buy producer goods. Advantages • Access to large sums of money. • Spread payments/instalments. • If successful the money becomes immediately available • The goods become the property of the business immediately. Disadvantges • Eligibility ➔ hard to get ➔ business plan needed ➔ prove can pay back. • Interest charged ➔ will add to cost causing cash flow problems ➔ pay back more than borrowed. • Cost of repayments may be added to price ➔ causing a loss of customers. • Some businesses m...
• Loans/finance from family or friends (external)= Raising finance by borrowing from friends and family. Advantages • Money will be available immediately. • May not incur interest/pay back. Disadvantages • Limited funds may be available. • If loan is not repaid could damage friendships/cause family issues.
• Government Assistance (Grants) (external)= Funds given by charities or the government to help businesses get started. Advantages • Usually given to businesses in regions where unemployment is high. • Often they are grants which do not have to be repaid. Disadvantages • They tend to be small amounts that last only for a relatively short period of time. • Very hard to obtain ➔ they are also few and far between due to strict criteria.
• Share Capital/ Issue (external) =Funds raised by issuing shares in return for cash. Advantages • There are no interest or repayment costs attached to it. Disadvantages • It is a source of finance only available to limited companies • It is costly ➔ means giving away some of the company and its profits to investors.
• Finance::sources of Finance Take on a Partner (external) Funds raised by inviting an individual to join the business who then invests money. Advantages • They invest capital without interest payments. • They offer expertise, skills, specialisations. Disadvantages • The owner will lose some control • The profits will be distributed between partners/ shareholders.
• Venture Capital (external)=Involves private investors providing capital to new or small businesses which have the potential for growth. Advantages • Possibly large sums of money can be attained quickly . • Advice may also be given. Disadvantages • Likely to lose full control of the business as the business angels will want a share of the business in exchange for their investment.
• Business Angels (external) Are wealthy individuals who invest their private capital into start-up businesses in return for a share in the business. Advantages • Possibly large sums of money can be attained quickly . • Advice may also be given. Disadvantages • Likely to lose full control of the business as the business angels will want a share of the business in exchange for their investment.
• Factors a business will need to consider if it is trying to raise extra finance =• Availability of finance ➔ some banks may not lend ➔ willingness of banks to lend • Interest charged ➔ will add to cost / may add to price • Time for repayment ➔ to spread cost over time / lower repayments • Amount of money needed ➔ banks not willing to lend large amounts / effect on interest • Effect on business ownership ➔ more shareholders = less control • Administration charges ➔ will add to costs ➔ reason for borrowing ➔ long-term / short-term ➔ capital / expenses etc.
• Functions of the Accounts/Finance Department=Functions of the Accounts/Finance Department: • Keeps financial records/accounts/“the books”. • Draws up financial tables ➔ profit and loss account/balance sheet/cash flow/budgets. • Deals with wages. • Settles bills/pays creditors. • Collects/chases up debt. • Organises loans etc. ➔ liaises with banks.
• Fixed Costs Definition: Costs which do not change with the number of goods made or sold. Examples: • rent for the shop • monthly lease on equipment and machinery • payment of business rates on premises.
• Variable Costs Definition: A cost that changes with the number of goods produced/sold/output. Examples: • raw materials • electricity and gas.
• Cash Flow Definition: The money that flows into and out of a business on a day-to-day basis.
• Cash Flow Forecast Definition: Sets out a business’ expected inflows and outflows of cash over a period of time.
• why are cash flows important? • May be part of a business plan ➔ when a business wants to borrow money. • Forewarns about future possible cash flow problems ➔ helps a business to put a plan in place. • Helps bank decide whether to give loan ➔ suggests ability to repay.
• External events which may result in the actual cash flow being different from the forecast: • Increased/decreased taxes ➔ will change the amount of cash held • Interest rates ➔ change in amount of cash given to banks • Legislation ➔ may change the services offered and therefore cash available ➔ minimum wage • Weather ➔ will change number of goods sold/ expenditure of customers • Increase in costs ➔ wages/fuel etc. • Inflation ➔ increase costs ➔ reduce customers • Competition ➔ attracts customers away • Breakage of equipment ➔ fewer items to sell ➔ costs of repair.
• Expenses of a Business Examples: • rent / salary / wages / utilities / tax / fuel / insurance / marketing / telephone / broadband / business rates.
• Opening Balance Definition: The cash available to a business at the start of a month, carried over from the closing balance of the previous month.
• Ways to Improve Cash Flow Position= • Reducing staff ☑ will reduce the wages bill ☒ but this may lead to an inferior service ➔ or reduced output ➔ loss of customer ➔ so revenue may fall. • Buying cheaper materials ☑ will reduce production costs ➔ and lead to lower prices ➔ which could generate more custom ☒ but customers will not be happy about the quality of the product ➔ so sales may fall. • Delaying payment to creditors ☑ will allow cash to be used for other purposes ☒ but suppliers may become reluctant to offer trade credit. • Chasing up bad debtors ☑ may genera...
• problems of cash-flow= Salaries stretch /No working capital /Creditor arrears /Taxation arrears /Overdraft at limit /Lack of profitability
• What Stakeholders Interested in Business Accounts =• Directors ➔ security of position ➔ to measure whether past planning has been a success ➔ and to aid decision-making for future. • Worker ➔ to see whether the business is successful ➔ which will impact on job security ➔ also could business afford wage increase. • Managers ➔ to see whether the business is successful ➔ which will impact on job security ➔ also could business afford salary increase ➔ do they qualify for bonus? ➔ has their management been effective? • Shareholder/investors ➔ to see whether the busine...
• What are the Reasons for changes in the Gross or Net Profit Margin: • Sales Revenue has increased or decreased • Costs of Goods Sold have increased or decreased • Expenses have increased or decreased.
• Profit Definition: The difference between the total revenue of a business and the total costs of a business, when revenue is greater than cost. It is important in being precise in using this term: stating “money made” can be confusing.
• Ways to Increase Profit: • Decrease price ☑ increase market competitiveness ☒ looks like poor quality ➔ no increase in sales means lower profits. • Increase the price charged ☑ will increase the revenue that is made per sale/ customer ☒ but may lose customers if they don’t want to pay the higher price. • Reduce costs / example of cost reduction ☑ this will ensure that the business makes more profit per customer ☒ but the quality of the service may fall resulting in a loss of customers and less revenue. • Increasing marketing ☑...
• Ways to improve turnover(revenue): • Increase price ➔ make more revenue per item sold. • Reduce price ➔ may create demand/sell more goods to increase total revenue. • Increase promotion/advertising ➔ may attract more customers/ sales.