5.3 - Sources of finance

• Finance


  Money needed by businesses to buy fixed assets and pay day-to-day costs
• Sources of finance


  • Internal
  • External
• Internal finance


  Money from within the business, e.g. profit
• External finance


  Money from sources outside the business, e.g. bank loans or shareholder investments
• Short-term finance


  Finance repaid within 1 year
• Long-term finance


  Finance repaid over a longer period, usually 3 years or more
• Factors to consider when choosing a source of finance


  • Legal structure of the business
  • Amount of money required
  • Level of risk involved
  • Short-term or long-term finance needed
• Retained profit


  Profit can be retained and built up over the years for later investment
• Benefits of using retained profit


  • Business doesn't have to pay interest
  • Drawbacks: shareholders may object, business may miss investment opportunities
• Rationalisation


  Managers reorganise the business to make it more efficient by selling assets and leasing them back
• Benefits of rationalisation


  • Business doesn't need to pay interest
  • Drawbacks: business no longer owns the asset, leasing introduces another cost, assets lose value over time
• Overdraft


  Bank lets a business have a negative amount of money in its bank account
• Advantages of overdrafts


  • Easy to arrange, flexible, only pay interest on amount used
• Disadvantages of overdrafts


  • Banks charge high rates of interest, may be fixed charges
• Debt factoring


  Banks/financial institutions take unpaid invoices off the hands of the business and give them an instant cash payment (less than 100% of invoice value)
• Advantages of debt factoring


  • Businesses can instantly get money they are owed
• Disadvantages of debt factoring


  • Debt factoring company keeps some of the money owed as a fee
• Loans


  Businesses can borrow a fixed amount of money and pay it back over a fixed period of time with interest
• Bank loans


  • An external source of finance
  • Businesses can borrow a fixed amount of money and pay it back over a fixed period of time with interest
  • The amount they have to pay back depends on the interest rate and the length of time the loan is for
• Security for a loan


  • Usually in the form of property
• Loans


  • A good long-term source of finance for a start-up business and for paying for assets like machinery and computers
  • Not a good way to cover the day-to-day running costs of the business
• Share capital


  Money raised by selling shares in the business
• Venture capital


  Funding in the form of share or loan capital that is invested in a business that is thought to be high risk
• Venture capitalists


  • Professional investors who invest in businesses they think have the potential to be successful
  • They may also provide business advice
  • Applying for funding is a long process
• Crowdfunding


  A method of financing a business or project using contributions made by a large number of people, usually done via the internet