2.1 Raising finance Flashcards
What is capital expenditure?
Spending on items that may be used over and over again
What is an example of capital expenditure?
A company vehicle
A cutting machine
A new factory
What is revenue expenditure?
Payments for goods and services that have either already been consumed or will be very soon
What is an example of revenue expenditure?
Wages
Raw materials
Maintenance and repair of buildings
What are examples of internal finance?
Owner’s capital: personal savings
Retained profit
Sale of assets
Owner’s capital
The money provided by the owners in a business eg savings, inheritance, redundancy
What are advantages of owner’s capital?
+ Does not have to be repaid
+ Carries no interest chargers
+ Owner maintains control
What are disadvantages of owner’s capital?
- Owners risk losing everything
- May only be limited amounts available
What is owner’s capital best for?
Starting a small business
Retained profit
Profit after tax that is put back into business and not returned to the owners
What are advantages of retained profit?
+ Belongs to the business already
+ Does not involve debt
+ No need to repay it
+ No interest to pay
What are disadvantages of retained profit?
- May not be enough to meet finance needs
- Useless for start-ups as they will not have any retained profits
What is retained profit best for?
Expanding an existing business
Sale of assets
An established business can sell unwanted assets (items of value owned by a business) to raise finance: machinery, obsolete stock, buildings etc.
What is a sale and lease agreement?
Selling property or machinery the business still needs and then leasing back from from specialist
What are advantages of sale of assets?
+ Rid of obsolete items for finance
+ No interest charges
+ Immediate lump sum cash injection
What are disadvantages of sale of assets?
- Expensive in long run if need to lease asset back
- Loss of asset use and future value
What is sale of assets best for?
Raising money quickly
What are examples of external sources of finance?
Family & friends
Banks
Peer-to-peer funding
Business angels
Crowd funding
Other businesses
Family & friends
Investment from people known to the entrepreneur
What are advantages of family & friends?
+ May be flexible
+ May offer loans without collateral
+ May provide interest-free or low rate finance
+ May be happier with a longer repayment period
What are disadvantages of family & friends?
- Problems may damage relationships
- Amount may be limited
- Lenders may lose their money
- They may also want to be more involved in the business
What is family & friends best for?
Small businesses running as a sole trader or possibly a partnership
Banks
Commercial banks, such as Barclays, provide external funding arrangements (loans, overdrafts, mortgages)
Specialist departments and employees for business banking offering advice on topics like methods of finance
What are advantages of banks?
+ Fixed sum available via loans - easy to plan for fixed repayments
What are disadvantages of banks?
- Often difficult to persuade banks to lend - may not be flexible
- Require interest repayments
- May require collateral
What are banks best for?
Established businesses with a credit record. Overdrafts for short term cash flow problems.
Peer-to-peer lending
Allows savers to lend money direct to individuals or small businesses via specialist websites
What are advantages of peer-to-peer lending?
+ Gives borrowers access to funds at advantageous rates compared to some other forms
What are disadvantages of peer-to-peer lending?
- Loans are unsecured
- No previous knowledge or relationship
- Peer to peer sites charge
- Cash may not be instant
What is peer-to-peer lending best for?
Small established businesses so not suitable for big firms or start ups
Business angels
Wealthy individuals make personal investments into start-up businesses in return for a share of business
What are advantages of business angels?
+ Normally very knowledgeable and experienced in business
+ May act as mentors
+ Provides advice and guidance
What are disadvantages of business angels?
- Requires some form of equity which gives them a measure of control
- High risk as business is not established
What are business angels best for?
Newer and possibly high risk, early stage or high growth businesses
Crowd funding
It involves raising finance from a large number of people each investing different amounts of money. Business use internet to explain how much money is required etc.
What are advantages of crowd funding?
+ Millions of potential founders can be reached nationally
+ Investor is only tied into their promised contribution if total amount raised
What are disadvantages of crowd funding?
- No guarantee that it will raise sufficient finance
What is crowd funding best for?
Unusual ideas and projects that might not attract other forms of finance
Bank loans
A set amount of money provided for purpose, repaid with interest, over time. They’re secured against an asset and if there is a default on repayments the asset is taken.
What are advantages of bank loans?
+ Quick and easy to secure
+ Fixed interest rates allow firms to budget
+ Improved cash flow
What are disadvantages of bank loans?
- Interest just be paid regardless of financial performance
- A firm normally provides security - collateral
- More expensive source
- Can be charged penalty for early payment
What are bank loans best for?
Longer term projects
Overdrafts
Facility to overspend on a current account up to an agreed sum. Business can withdraw money from the account that is not there meaning they go overdrawn.
What are advantages of overdrafts?
+ Only borrowed when required allowing flexibility
+ Only pay for money borrowed
+ Quick and easy to arrange
+ No charges for paying off overdraft
What are disadvantages of overdrafts?
- Bank can call it in at any time
- Available from current bank account
- Interest variable making it difficult to budget
- Banks may secure overdraft against business assets
What are overdrafts best for?
Short term projects
Venture capital
Investment from an established business into another business in return for a percentage equity in the business
What are advantages of venture capital?
+ Benefit from expertise and mentoring from capitalist
What are disadvantages of venture capitalist?
- Usually require a stake in the business in return for finance and often expect to exert some control over business
Share capital
Finance raised from sale of shares, form of equity capital ie shareholder becomes a part owner of the business
What are advantages of share capital?
+ Only need to pay dividends if a profit is being made and amount of dividend is not fixed
+ Possible to raise large amounts of finance
+ No interest payments
What are disadvantages of share capital?
- Loss of ownership as shareholders are part owners
- Potential risk of loss of control for a PLC with a threat of hostile takeovers
- Complex and costly process of issuing shares
Grants
Fixed amounts of capital provides to business by the government or other organisations to fund specific projects
What are advantages of grants?
+ No need to repay
What are disadvantages of grants?
- Business must use the finance for its intended purpose
Trade credit
Business buy raw materials, components and fuel and pay for them at a later date (30-90 days)
What are advantages of trade credit?
+ Usually interest free
+ Profitable with inflation time
What are disadvantages of trade credit?
- Cost can be higher if business does not pay early
- Payment delay leads to bad relationship with suppliers
What is an unlimited liability business?
Businesses where there is no legal difference between the owners and the business. They are sometimes called unincorporated businesses. Everything is carried out in the name of the owner.
What is a limited liability business?
Business has a legal identity separate from its owners. The business can be sued, taken over or liquidated. They are sometimes called incorporated businesses.
What are implications of unlimited liability?
• Owners are exposed to financial failure of business
• Debts will have to be funded by personal resources
• Owners are liable for any unlawful acts committed by the owners or employees
• Easier to raise finance (lenders reimbursed if business defaults and owners could be seen as more credible)
What are implications of limited liability?
• Shareholders’ financial liability is limited to the amount of money they invested
• If limited company collapses, the owner’s private assets are protected
• Shareholders have protection from legal claims (unless crime)
• Easier to raise larger amounts - investors know extent of liability
How does a business choose appropriate finance?
• Decide whether short-term or long-term finance is needed
• The financial position of the business
• The type of expenditure for which the money is needed
• Cost
• The legal status of the business
What sources of finance are appropriate for unlimited liability businesses?
• Personal savings
• Retained profit
• Mortgage
• Unsecured bank loans
• Peer-to-peer lending
• Crowd funding
• Bank overdraft
• Grants
Why are these sources of finance appropriate for unlimited liability businesses?
They are accessible to small business. Businesses with unlimited liability tend to be small and often struggle to raise finance. Such businesses have access to fewer sources because they have fewer assets that can be used as collateral.
What sources of finance are appropriate for limited liability businesses?
• Share capital
• Debentures
• Retained profit
• Venture capitalists
• Business angels
• Other sources
Why are these sources of finance appropriate for limited liability businesses?
One reason is due to their legal status. For example, only limited companies can issue shares to raise finance. Other sources, such as business angels and venture capitalists, are likely to be appropriate because they prefer to invest in, or lend to, larger businesses.
Why are these sources of finance appropriate for limited liability businesses?
One reason is due to their legal status. For example, only limited companies can issue shares to raise finance. Other sources, such as business angels and venture capitalists, are likely to be appropriate because they prefer to invest in, or lend to, larger businesses.
Why do businesses use business plans?
Start-up businesses that have prepared a business plan are more likely to succeed than those that have not. It is also needed to support applications for finance.
What is a business plan likely to do?
• Force owners to take an objective, critical look at the idea
• Provide a clear direction for the development
• Provide an action plan that identifies key tasks and goals
• Flag up potential problems in advance
• Show lenders and investors that the owner is cautious and responsible
What does a business plan contain?
• An executive summary
• The business opportunity
• Buying and production
• Financial forecasts
• Business objectives
• Market
• Personnel
• Premises and equipment
• Finance
What is a cash-flow forecast?
It is an estimate of future inflows and outflows of the business usually on a monthly basis. It shows the expected cash balance at the end of each month.
What are advantages of cash-flow forecasts?
+ Helps to identify cash shortages to borrow cash or surpluses to buy new equipment
+ Supports applications for finance when lenders insist on checking credibility
+ Enhances the planning process
+ Monitors cash flow to help make comparisons between predicted and actual figures
What are limitations of cash-flow forecasts?
- Financial info is based on estimates so if figures are inaccurate, findings will be unreliable
- Business activity is subject to external factors beyond control
- Needs regular updating so time is taken gathering resources
- Only focuses on one variable - cash
What is cash inflow?
Money coming into the business
What is cash outflow?
Money going out of the business
How do you calculate net cash flow?
Total Inflow - Total Outflow
How do you calculate opening balance?
Same as the months before closing balance
How do you calculate closing balance?
Net Cash Flow + Opening Balance
How can a business speed up inflows?
• Discount for early payments
• Reduce trade credit length
• Destock
• Loan/overdraft
How can a business slow down outflows?
- Delay paying creditors
- Reduce costs
