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
