2.1 Raising Finance Flashcards
Where does internal finance come from?
Internal finance comes from the owner’s capital, retained profit or the sale of assets
How is ‘owners capital’ (personal savings) used?
Owners may introduce their savings or another lump sum e.g. money received from a redundancy payment
Owners may invest more as the business grows or if there is a specific need e.g. a short-term cash flow problem
How is retained profit used within a business?
The profit that has been generated in previous years and not distributed to owners is reinvested back into the business
This is a cheap source of finance, as it does not involve borrowing and associated interest and arrangement fees
How is sale of assets used within a business?
Selling business assets which are no longer required (e.g. machinery, land, buildings) generates a source of finance
What are the advantages of using internal sources of finance?
- Internal finance is often free (does not involve payment of interest or charges)
- Does not involve third parties who may want to influence business decisions
- Businesses that may fail credit checks (necessary for bank loan) can access internal sourced more easily
What are the disadvantages of using internal sources of finance?
- There is a significant opportunity cost involved in the use of internal finance e.g. once retained profit has been used it is not available for other purposes
- Internal finance may not be sufficient enough to meet the needs of the business
What external sources of finance are there?
- Family & Friends
- Banks
- Crowdfunding
- Peer-to Peer lending
- Business Angels
- Other Businesses
What are the advantages and disadvantages of family and friends as a source of finance?
Advantages:
- Usually a very cheap source of funds
- May have ‘no strings attached’ (e.g. a share of the business) and can be provided to the business on very flexible terms
Disadvantages:
- Relationships may be damaged if the finance is not repaid
What are the advantages and disadvantages of bank loans?
Advantages:
* May offer both short term finance (e.g. overdrafts) and long term finance (e.g. loans or mortgages) if a business qualifies
* Banks are often keen to provide free advice and guidance to businesses that use their services
Disadvantages:
* Banks can be cautious about lending to new, untested businesses
* A business plan is usually required to access bank finance
What is peer-to-peer funding?
A type of business loan where they bring together people or businesses that want to lend money with those that want a loan.
What are the advantages of peer-to peer funding?
Advantages:
* Loans can usually be made available to businesses very quickly
* Usually has ‘no strings attached (e.g. a share of the business)
Disadvantages:
* Borrowers are charged a small fee to access finance in this way and have to pay interest in the same way as a bank loan
–> The individuals who made the money available in the first place receive some of this interest as compensation
What are business angels?
Individuals that specialise in making investments in start-up or expanding businesses
e.g. Dragons Den investors
What are the advantages and disadvantages of business angels?
Advantages:
* Business angels tend to be more willing to take a risk than banks
- Angels often offer advice and guidance to the businesses in which they invest
Disadvantages:
* Finding the ‘right’ business angel (e.g. with appropriate experience, expertise or interest) can be challenging
- As business angels own a stake in the business, they may be involved in decision-making and will receive a share of business profits
What is crowdfunding?
Crowdfunding allows businesses to access finance provided by a large number of small investors on online platforms.
What are the advantages and disadvantages of crowdfunding?
Advantages:
- A good credit rating is not required so new businesses that lack a trading record can attract funding
Disadvantages:
* Businesses need to provide a persuasive business plan to convince individuals to invest in their product as they will be competing with many other projects online
* Potential for negative publicity if the project is not successful in attracting enough crowdfunding capital
What are ‘other businesses’ as a source of external finance?
May be possible for a business to access finance via a joint venture with another business, such as a key customer or supplier
What are the advantages and disadvantages of ‘other businesses’?
Advantages:
* May provide access to business processes and market knowledge alongside finance
* Can access large amounts of finance
Disadvantages
* Profits need to be shared between businesses
* Decisions will usually need to be agreed by all of the businesses involved
What methods of finance are there?
- Loans
- Share Capital
- Venture capital
- Leasing
- Overdrafts
- Trade credit
- Grants
What is a loan?
A sum of money is borrowed and repaid (with interest) over a determined period of time
What are the advantages and disadvantages of bank loans?
Advantages:
- Interest rates are fixed for the term of the loan
- Repayments are made in equal instalments, helping budgeting
Disadvantages:
- Interest rates depend on the businesses credit rating
What is an overdraft?
An arrangement for business current account holders to spend more money than it has in their account
A limit is agreed and interest is charged only when a business ‘goes overdrawn’
What are the advantages and disadvantages of an overdraft?
Advantages:
* A short-term source of finance that offers significant flexibility and aids cash flow
Disadvantages:
* An overdraft may only be ‘called in’ if the bank is concerned about a business’s ability to repay what it owes
What is share capital?
Share capital is finance raised from the selling of shares in a limited company
Shareholders are the owners of shares and they are entitled to a share of the company’s profit when dividends are declared
What are the advantages and disadvantages of share capital?
Advantages:
* Large amounts of capital can be raised, especially by public limited companies
- Interest is not payable on finance raised in this way
Disadvantages:
* Shareholders usually have a vote at a company’s Annual General Meeting (AGM) where they can have a say in the composition of the Board of Directors
* Diminished control
What is venture capital?
Funds provided by specialist investors in small to medium-sized businesses that have significant potential for growth
e.g. in the technology sector
What are the advantages and disadvantages of venture capital?
Advantages:
* Businesses that may have been refused finance from other sources may be able to attract investment from less risk-averse venture capitalists
Disadvantages:
* Venture capitalists usually require a stake in the business in return for finance and often expect to exert some control over the business
What is leasing?
An asset such as a piece of machinery or a vehicle used by the business in return for regular payments
What are the advantages and disadvantages of leasing?
Advantages:
* The business does not own the asset during the period of the lease and so is not responsible for maintenance or repair costs
Disadvantages:
* Leasing is usually more expensive in the long run than buying an asset
What is trade credit?
An agreement is made with suppliers to buy raw materials, components and stock which are paid for at a later date, typically 30 to 90 days later
What are the advantages and disadvantages of trade credit?
Advantages:
- Trade credit is usually interest-free
- Means the business doesngt have to pay it in full all at once
Disadvantages:
- Discounts for early payment will not be available
What are grants?
Governments and industry trusts may offer grants to businesses that meet specific criteria
What are the advantages and disadvantages of grants?
Advantages:
* Grants do not need to be repaid
Disadvantages:
* The business must use the finance for its intended purpose
What type of legal strucutre do soletraders and partnerships have?
Sole traders & partnerships offer no legal protection to the owners in that the business assests and the owners personal assets are viewed the same
What legal structure do the other forms of business have?
Other forms of business ownership offer limited liability in which the assets of the owners are considered to be seperate from those of the business
What is unlimited liability?
- Sole proprietors and partnership owners are fully responsible for all the debts owed by the business
- Owners also legally responsible for any unlawful acts committed by those connected to the business
What are the implications of unlimited liability?
There is no legal distinction between owners with unlimited liability and the business
As a result business owners may have to use their own personal assets to pay debts or legal fees
e.g a sole proprietor may need to sell thier home to pay creditors if their business fails
What is limited liability?
Owners (shareholders) of private limited companies and public limited companies can only lose the original amount they invested in the business if it fails
Shareholders are not responsible for business debts- In most cases the shareholders cannot be held responsible for unlawfulmacts committed by those connected with the business
What are the implications of limited liability?
Companies are incorporated (legally established) and owners are considered a separate legal entity to the business
This means owners can undertake riskier ventures without fear of losing personal assets.
This can lead to more profitable outcomes for the business, maybe they take the risk of investing in a new product/launching in anew market & it is highly successful
This means that if a company fails, the owners would lose their investment (shares) but would not have to use their assets to meet additional debts or legal fees.
What are the other benefits of limited liability?
- Easier fundraising
A private limited company can raise capital more easily than a sole trader by issuing shares.
This can attract investment from family,friends & external investors
What internal and external methods of finance are suited for limited liability businesses?
Internal:
Retained Profit
Debentures
External:
Venture capitalists
Share capital
Business angels
What sources of finance are suitable for unlimated liability businesses?
Internal:
Personal savings
Retained profit
Bank:
Unsecured loan
Overdraft
Mortgage
Suppliers:
Trade credit
Leasing
Investors:
Crowd funding
Peer to peer lending
External Bodies:
Grants
What is the main aim of a business plan?
To reduce the risk associated with starting a new business
What actually is a business plan?
A document produced by the owner at start-up which provides forecasts of items such as sales, costs and cash flow
What does a business plan allow?
Allows lenders (e.g banks) & other investors to analyse the plan and make an informed decision about providing a loan
Forces the business owner to think about every aspect of the business before they start which should reduce the risk of failure
What is a cash-flow forecast?
A prediction of the anticipated cash inflows and cash outflows, typically for a 6-12 month period
How do you work out net cash flow?
Cash inflows - Outflows
How do you work out the opening balance?
Previous month’s closing balance carried forward
How do you work out the closing balance?
Net cash flow + Opening balance
What are the advantages of cash flow forecasts?
- Can support an application for a loan and are an integeral part of the business plan
- They can help identify where the business may experience cash shortfalls or cash surpluses so that plans can be made to manage these periods (e.g arranging an overdraft)
- Cash flow forecasts aid planning and help a business avoid costly mistakes
What are the disadvantages of cash flow forecasts?
- Forecasts are usually based on estimates and in reality inflows and outflows may differ significantly from the estimates
- Cash flow forecasts require apporpriate skills insight research and time to prepare and update adequately which some people may not be able to do so
- External factors that can impact inflows and outflows may not be reflected in the cash flow forecast
