1.3.4 sources of business finance

Question 1

Why may a business need new sources of finance?

Answer 1

paying for expenses
expanding the business
investing in new products and services
starting a new business

Question 2

What are some short term sources of finance

Answer 2

overdraft
- trade credit

Question 3

What are some long term sources of finance?

Answer 3

personal savings
venture capital-investors funding new business idea
share capital-selling shares in a limited company
loan
retained profit
crowd funding

Question 4

What are the names of the people who own a percentage of a business?

Answer 4

Shareholders

Question 5

Bank overdraft:

Answer 5

short-term source of finance that is available to help fund the day-to-day payments required by a business
allows the business to withdraw funds from its accounts that are not there, up to an agreed maximum limits and is only used when the business requires additional, temporary amounts of money

Question 6

Benefits of using bank overdraft as a source of finance for businesses:

Answer 6

offers flexibility important source of finance for a business if it has a short-term shortage of cash or unexpected cost to pay
interest only paid on amount used
covers short-term expenses that can be repaid quickly
helps solve cash-flow problems as negative cash flow in an immediate problem so it required short-terms source of finance to resolve the problem

Question 7

Drawbacks of using bank overdraft as a source of finance for businesses:

Answer 7

repayable to bank at any time
a bank may lower or even withdraw the overdraft facility at any time
usually has high levels of interest; using overdrafts is therefore an expensive form of finance → higher fixed costs → as a result profits of the business may fall
short term source of finance → means they are not used to secure finance for long-term projects → as a result, businesses may not be able to fund investments such as new buildings

Question 8

Trade credit:

Answer 8

trade credit is provided by a firm’s suppliers, allowing the business to have the goods now and pay for them at a later date

Question 9

Drawbacks of using trade credit as a source of finance for businesses:

Answer 9

danger of bad reputation and losing future credit arrangements with these upper, if bills are not paid on time
difficult for new start-up businesses to negotiate trade credit withs suppliers, as there is a risk that the businesses will fail and suppliers may not end up getting paid

Question 10

Benefits of using trade credit as a source of finance for businesses:

Answer 10

trade credit can allow the business to use the goods in the manufacturing and/or sell the goods before it pays the suppliers, which will improve its cash-flow position
paying for stock or goods later (e.g. 30 days or 60 days after), when the goods gave already been sold
helps solve cash-flow problems as negative cash flow in an immediate problem so it required short-terms source of finance to resolve the problem

Question 11

Personal savings/sources:

Answer 11

an entrepreneur will often invest personal savings, redundancy or inheritance money into a start-up
can also be in the form of providing assets for the business e.g. an entrepreneur using his/her own car

Question 12

Benefits of personal saving/sources as a source of finance for businesses:

Answer 12

provides a strong signal to other potential investors and the bank of the entrepreneurs commitment to the business
interest free readily available and maximises control the entrepreneurs keeps over business
coverings short-term expenses that can be repaid quickly

Question 13

Drawbacks of personal saving/sources as a source of finance for businesses:

Answer 13

amount that is available may be limited, resulting in the entrepreneur having to use other sources of finance to fund the business

Question 14

Bank loan:

Answer 14

an amount of money borrowed for a set period with an agreed repayment schedule
the repayment amount will depend on size and duration of loan, as well as rate of interest

Question 15

Benefits of using bank loans as a source of finance for businesses:

Answer 15

business is guaranteed the money for a certain period - generally 3-10 yrs
no need to provide bank with share in business, so no control is lost
interest rates may be fixed for the term, making it easier for an entrepreneur to forecast interest payments and cash-flow
repayments are made in instalments meaning the business can access substantial amounts of cash that doesn’t need to be paid in one go

Question 16

Drawbacks of using bank loans as a source of finance for businesses:

Answer 16

time consuming - a new business would need to produce a detailed business plan in order to gain a bank loan
security - normally has to be given to the bank on of the assets of the business/entrepreneur’s personal assets; the bank will have control over these assets if the business fails
lack of flexibility - a small business might take a loan out for £50,000, but finds it only needed £30,000; interest must be paid on the full loan amount, which increases the cost of the business

Question 17

Share capital:

Answer 17

small or new businesses that are set up as private limited companies can raise finance by selling shares in the company
a limited company can sell shares to potential investors to raise capital - these investors are then shareholders in the business and are entitle to share of any profits that are generated

Question 18

Benefits of share capital as a source of finance for businesses:

Answer 18

large sums of money can be raised by selling equity in a limited company
capital onset have to be repaid

Question 19

Drawbacks of share capital as a source of finance for businesses:

Answer 19

possible loss of control if the original owners sell more than 50% of the total shares
need to satisfy shareholders expectations of dividends and share price growth
no interest - dividend payments can be missed if profits are low

Question 20

Venture capital:

Answer 20

venture capital can be gained from professional investors, who typically invest £10,000 - £750,000 into a business that may be seen as high risk but have the potential to be very successful
venture capitalists tend to have made their own money by setting up and selling their own business - in other words they have proven entrepreneurial expertise

Question 21

Benefits of venture capital as a source of finance for businesses:

Answer 21

venture capitalists often make their own skills, experience and contacts available to the firm
raising capital from investors to fund a new idea - venture capitalists have access to large amounts of funds

Question 22

Drawbacks of venture capital as a source of finance for businesses:

Answer 22

the venture capital company or investors will usually want a share of the business and of the profits, which an result in some loss of control over the firm for the entrepreneur which they might not want to give up
unless a business can offer the prospect of significant turnover growth within five years, it is unlikely to be of interest to a venture capital firm

Question 23

Retained profit:

Answer 23

when a business has worked out its profits, the owners or shareholder and decide whether to take the profits for themselves of reinvest the profits back into the business to ensure it continues growing

Question 24

Drawbacks of retained profit as a source of finance for businesses:

Answer 24

if a business needs some temporary finance because it is facing difficulties, then it is unlikely to have any profits that it can use
growth may be slow if it is dependent on retained profits, as profits may not be high enough to finance the growth quickly
using too many profits in the business, may upset shareholders, who feel that their dividend payments are too low

Question 24

Benefits of retained profit as a source of finance for businesses:

Answer 24

a cheap form of finance, as no interest has to be paid
flexible - business owners have complete control over how any profits are reinvested and the proportion that is kept in the business, rather than paid out of dividends
retained profits do not dilute or reduce the ownership of the organisation so for companies, there is no risk of takeover

Question 25

Crowdfunding:

Answer 25

a way of raising money through a crowd funding platform, publicising a proposal seeking to attract a large number of worldwide small investors

Question 26

Benefits of crowdfunding as a source of finance for businesses:

Answer 26

provides cheap investments when other sources of external finance may not be available
if the project is newsworthy, it might attract good publicity
social media can be easily used to keep investors informed of the progress of the business venture, which might then provide ongoing finance
investors may have experience or skills that they can offer the business

Question 27

Drawbacks of crowdfunding as a source of finance for businesses:

Answer 27

investors will need to be offered a return; this might be free use of the good or service produced or a share in the profits - some schemes will also provide shares, which dilutes the control of the original owners of the business
risk that there will be a limit to the amount of money investors are willing to invest
the business idea may not be of interest and attract little finance; time and money spent organising the crowdfunding campaign will be lost