Sources of finance

• Sources of finance


  • Internal sources
  • External sources
• Internal finance


  Funds generated by and within the firm
• Internal finance


  • No set repayment date
  • No interest
• Internal sources of finance


  • Capital contribution
  • Retained profits (owner's equity)
• External finance


  Funds generated from sources outside the business
• External finance


  • Readily available
  • Flexible
  • May carry a high interest charge
  • May be recalled at short notice
• External sources of finance


  • Bank overdraft
  • Trade credit
  • Lease
  • Loan (liabilities)
• Capital contributions


  Funds contributed by the owner to commence, support or expand business operations
• Capital contributions


  • Most important source of finance when a business is just starting
  • Covers initial set up costs
  • Covers operating costs until the business is self-sufficient
• Retained earnings


  Business profits that are kept to fund further expansion
• Retained earnings


  • Generally only available to well established and profitable businesses
  • Owner has chosen to limit drawings
• Trade credit


  Facility offered by the supplier that allows its customer to purchase goods or services immediately and then pay at a later date
• Trade credit


  • Allows immediate access to goods/services
  • Allows businesses time to generate sales before payment is required
  • No interest charge if credit terms are met
  • Discounts are available from some suppliers for early payment
• Bank overdraft


  Facility provided by a bank that allows a business to withdraw funds greater than the current balance of its account
• Bank overdraft


  • Readily accessible
  • Flexible - can be used for a variety of purposes
  • High interest charge
  • Can be recalled at short notice
• Term loans


  Funds provided by a bank or other lender for a specific purpose and repaid over time
• Term loans


  • Make possible the purchase of expensive assets
  • Flexible - can be used for a variety of purpose
  • Secured loans attract a lower interest rate
• Leasing


  A form of rental agreement that allows a business to use and control an asset for a length of time in return for specific periodic payments
• Leasing


  • Reduces initial outlay to acquire assets
  • Allows assets to be updated when they become outdated or technologically obsolete
• Mortgage loans


  Loan usually over 25 or 30 years, with the title to a property being provided as security for the loan
• Guidelines for seeking external finance


  • Term of the finance should match the life of the asset
  • Cost of interest must be considered
  • Conditions of the loan should be tailored to suit the borrower
  • Consider the impact on the Debt ratio and the firm's ability to borrow further
• Flat rate interest


  Fixed percentage of interest is charged every year of the loan regardless of how much has already been repaid
• Reducing balance interest


  Interest charged each year will reduce as the amount owing is reduced
• Simple interest


  Payment of interest at a flat rate of the initial investment
• Compound interest


  Payment of interest that is added onto the initial investment and previous interest earned
• Information lenders consider when applying for a loan


  • Monthly income
  • Monthly expenses
  • Current credit commitment
  • Previous credit history
  • Details of accounting reports
• Information lenders consider when applying for a business loan


  • Amount and purpose of the loan
  • Business details
  • Ownership structure
  • Nature of operations
  • Future direction and goals
• Gearing


  The dependence of a business on borrowed funds
• Debt ratio


  Measures the extent to which a business relies on external finance to fund its assets
• Highly geared businesses


  • Higher interest costs
  • Higher loan repayments
  • More risk of financial collapse
• The lower the debt ratio percentage, the better the business is