Finance

• Many businesses fail because they do not manage their cash flows effectively
• Sources of finance


  Money that a business can use to fund its activities
• Both new and established businesses need to raise finance
• Reasons why new businesses need to raise finance

  • Renting or buying a building
  • Vehicles
  • Advertising the business
  • Equipment and machinery
  • Inventories of raw materials
• Reasons why established businesses need to raise finance

  • To expand
  • To improve efficiency
  • To develop new products
• Sources of finance


  • Internal sources: Owners' funds, Retained profits, Sale of unwanted assets, Trade credit
  • External sources: Bank loans and mortgages, Overdrafts, Share issues, Government grants
• Internal source of finance

  Money that is available from within the business
• Owners' funds


  Money put into the business by its owners.
• Retained profits


  Profit made by the business in earlier years that is kept within the business
• Retained profits form the most important source of finance for large businesses
• Asset


  Something that is owned by a business
• Trade credit


  A period of time which suppliers allow customers before payment for supplies must be made
• External source of finance

  Money that comes from outside the business
• Bank loan


  A bank gives a business a large sum of money in return for the business agreeing to repay the amount in instalments over the next few years, with interest
• Collateral


  An asset belonging to the business that is borrowing the money, which the bank has control of and the right to sell if the business fails to repay the loan
• Mortgage


  A loan from a bank or building society used by businesses to buy property such as offices, shops and factories
• Overdraft


  A flexible loan which businesses can use, whenever necessary, up to an agreed limit
• Building societies


  Organisations that offer a range of financial services, with their major business being providing savings accounts and lending money for the purpose of buying property
• How a new business might use its overdraft


  • Balance falls and becomes negative in early months of trading
  • Business spends heavily on advertising and supplying products
  • Times when the business is using its overdraft
• Overdrafts do have disadvantages for businesses
• New share issues


  Only companies can sell shares, which can be used in a variety of ways. The people who buy the shares are called shareholders and each owns a part of the company.
• It is much easier for public limited companies to sell shares as they can use the Stock Exchange - a market through which companies can sell shares
• Disadvantages of using the sale of shares as a source of finance

  • If the business sells a large quantity of shares, it may mean that the new owners (shareholders) have enough shares to take control of the business from the current owners
  • The new shareholders will expect to have a share of the company's profits (as dividends)
• Loans from friends and family

  A popular source of finance for many entrepreneurs who are setting up a small business. This source of finance has the advantage of being easy to arrange and often the money will be lent free of interest payments.
• Disadvantages of borrowing from friends and family

  • Friends and family may not be able to lend enough money or may need to have it returned suddenly, leaving the business short of finance
  • Friends and family will be less likely to look closely at the entrepreneur's business plan and to make the entrepreneur think carefully about the proposed business
• Hire purchase


  A method of purchasing assets and paying in instalments. It is really a special form of a loan. Hire purchase can be an expensive way of buying something, and the business will not own the item until it is completely paid for.
• Government grants


  A sum of money given to an entrepreneur or a business for a specific reason. The government encourages people to start or to expand businesses because this creates jobs.
• Advantages of government grants

  They do not have to be repaid and also do not lead to any interest payments
• Disadvantages of government grants

  • Businesses may have to meet a number of conditions, such as creating a certain number of jobs, in order to qualify
  • The application for grants can also involve completing a lot of forms and an interview
• Factors influencing the choice of sources of finance for new businesses

  • The amount of personal finance available
  • The legal structure of the business
  • How risky the new business is judged to be
  • The amount of finance needed
• Factors influencing the choice of sources of finance for established businesses

  • Profitability of the business
  • Assets owned by the business
  • Past history and future prospects
  • Legal structure of the business
  • Amount of finance that has to be raised
• Businesses can raise finance from a number of sources
• The best source of finance depends on the circumstances
• Entrepreneurs and managers might take into account the past and expected profitability of the business, the assets available to the business, its legal structure and the amount of money that the business needs to raise
• Mantra Ltd is a private limited company that manufactures sheds, bird tables and other garden furniture
• Mantra Ltd regularly uses its overdraft as a source of short-term finance
• Mantra Ltd has enjoyed rising sales over recent months, and its profits have risen steadily
• Mantra Ltd needs to build an extension to its factory and to buy new equipment for the enlarged factory, at a cost of £190,000
• The shareholders plan to use a bank loan to raise the entire £190,000
• Overdraft


  A source of short-term finance that can be used by companies