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3.1 Sources of Finance
Transcript of 3.1 Sources of Finance
Finance can come from two sources:
Finance - money raised from the businesses own assets or profits.
Finance - money raised from sources outside the business.
Why do businesses need $?
Finance is required for many business activities such as:
is finance spent on purchasing fixed assets.
refers to payment for daily running of a business such as wages.
- when a firm is unable to meet its debts.
To be able to understand the appropriate source of finance for specific business situations.
Define key financial terms.
Analyse internal finance options.
Evaluate external finance options
Internal Sources of Finance
Retained profit/ Ploughed-back profits -
any profit that remains after paying taxes and dividends.
Sale of assets -
established companies often find they have assets that are no longer used. Company may decide they do not need to own an asset so will sell it and lease it back.
Family and personal savings
Working capital -
sale of goods and services.
- companies can receive interest from savings
Evaluation - Internal sources of finance
This type of capital may have no direct cost to the business although there may be an opportunity cost.
Internal finance does not increase the liabilities.
There is no risk of loss of control by original owners as no shares are sold (if a plc or Ltd.)
However, it is not available for all companies, for example newly formed ones or unprofitable ones with few spare assets.
External Sources of Finance
There are three main types of
- The bank allows the business to "overdraw" on its account. It is a very flexible but does carry high interest charges.
- By delaying the payment of bills for goods or services received, a business is obtaining finance.
- When a business sells goods on credit it creates a debtor. Company sells the debts owed (for less) to a debt factoring company.
Finance is also divided into:
Short-term finance - < 1 year
Medium-term finance - 1 - 5 years
Long-term finance - 5+ years
Medium Term Finance
Long term finance
Sale of shares - equity finance
Evaluation - debt or equity capital
Other sources of long-term finance
is a form of credit for purchasing an asset over a period of time. This eliminates making a large cash payments. The asset is owned by the company.
involves a contract with a leasing or finance company to acquire (use) assets over the medium term. Again this avoids a cash purchase of an asset.
There are two main choices are
Debt finance can be raised in two main ways:
Long-term bank loans
- These can be either at variable or fixed interest rates. Need to provide collateral.
Businesses with few assets may be asked to pay higher interest rates.
- is a secured long term loan for the purchase of property such as land or buildings. If the borrower defaults on the loan the bank can repossess the property.
or long term bonds - bonds issued by companies to raise debt finance, often with a fixed interest rate. A company wishing to raise funds will issue or sell these to interested investors. The company agrees to pay a fixed interest rate over the life of the debenture (up to 25 years).
Private and public limited companies can sell shares. Many private business go public by having an Initial Public Offering (IPO).
- money raised from the selling of shares.
- selling more shares.
Types of shares
- received fixed amount from profits. lower risk.
- dividends dependent on profitability.
Which method of long-term finance should a company choose? There is no easy answer and some businesses will use both debt and equity financing.
As no shares are sold the ownership does not change..
Lenders have no voting rights at the AGM.
Interest charges are an expense
The gearing of the company increases. (ratio analysis)
It never has to be repaid - it is permanent capital.
Dividends do not have to be paid every year - conflict
Loss of ownership.
Can add expertise or business contacts.
- venture capitalists are organizations or wealthy individuals who are prepared to lend risk capital to purchase shares in business start ups of small to medium sized businesses that might find it difficult to raise funds from other sources.
Dragon's Den - Venture Capitalists
Finance for sole traders and partnerships
Making the financing decision
Aspiring entrepreneurs pitch to five British multi-millionaires, with the expertise - and the money - to turn great ideas into incredible fortunes.
Unincorporated businesses cannot raise finance from the sale of shares and are unlikely to be successful in selling debentures as they are a relatively unknown firm. Owners of these businesses will have access to bank overdrafts, loans and credit from suppliers. They may borrow from family and friends, use the savings and profits made by the owners, and if a sole trader wants to take on partners for further injections of cash.
An owner or partner in an unincorporated firm runs the risk of losing all property owned if the firm fails. Lenders are often reluctant to lend to smaller businesses.
The following factors also influence finance choice:
Purpose of finance
Size and Status of the firm
Legal structure and desire to retain control
Size of existing borrowing (gearing)
Briefly analyse the benefits and drawbacks of personal funds, retained profits and sale of an asset.
Bullet point two advantages and two disadvantages
Companies should always choose equity finance rather than debt finance, do you agree with this statement. 6 marks
Sources of Finance for Public Sector
Selling services e.g BBC
Donations e.g Universities.
Fund - raising e.g Hospitals
Key Criteria for the business angels:
Crowdfunding: An alternative approach to start up capital.
Venture Capitalists Dragons Den
MG Rover 3.1.7
Sale & Leaseback
3.1 Sources of Finance
External Finance Activity:
Short, medium or long term source
Bullet point analysis
Type of organization available for
is money raised from the selling of shares in a incorporated company.
source of finance
: no interest, dividend not payed unless profit is made, liabilities not increased, large amounts can be raised.
: ownership in diluted, share price may fall, IPO can be expensive.
Private and Public limited companies.
Discuss the impact on a new business start up of accepting an offer from a dragon.