2.1.1 and 2.1.2 - Sources & Methods of Finance Flashcards
Why do businesses need finance?
Businesses need finance to buy fixed assets, like factories and machinery.
Finance is also needed to pay day-to-day costs, like wages, so that the business can survive.
What is a source of finance? What is a method of finance?
Use the example: A sole trader has an overdraft on her bank account.
A source of finance is a provider of finance. The way in which a provider gives finance is a method finance.
e.g., A sole trader has an overdraft on her bank account - the bank is the source of finance and the overdraft is the method.
What are the two types of sources of finance?
- Internal
- External
What is the difference between a short-term and long-term source of finace?
A business may require short-term finance to pay its suppliers or cover temporary shortages of cash. Short-term finance is usually repaid within 1 year.
Long-term finnace is needed for long term investments. It can take a while for a business to benefit financially from investments like new machinery, so repayment of long-term finance are due over a longer period, usually 3 years.
When choosing a source of finance, what must a business consider?
- Amount of money required.
- Level of risk involved.
- Cost of the finance.
What is an internal source of finance?
Internal finance can be raised by using the owner’s money, selling assets or putting profits back into the business.
Give three examples if internal finance?
- Owner’s capital
- Selling assets
- Retained profit
What is owner’s capital?
Owner’s capital is money the owner (or owners) invest in the business, often from their personal savings.
Who is likely to use owner’s capital as their source of internal finance?
Sole traders or partenerships are likely to use this as a soyrce of finance when they’re starting up or exandinh - they’re often relatively small businesses that don’t need huge sums of money. Also they might’nt have access to other source of finance.
What are the advantages of owner’s capital?
- Easy to access
- Doesn’t need to be payed back.
What are the disadvantages of owner’s capital?
Amount of finance that can be raised is limited - it depends on the personal wealth of the owner(s).
What is a selling assets?
Business can seel some of their assets (e.g., factories, machinery, etc) to generate capital.
What business may use selling assets as their source of finance?
This source of finance is only appropriate for business with spare assets, so it’s not suitable for very new business or very efficient businesses (as they’re unlikely to have assets that they don’t use).
What are the advantages of selling assets?
Cheap source of finance, as no interest needs to be repayed.
What are the disadvantages of selling assets?
- selling assets means that the business no longer owns the asset.
- It can take a long time to sell the assets and get the cash.
What is retained profit?
This is profit re-invested back into the business. This can work in the short- and long-term.
Why can’t some business use retained profit as their source of finance?
Not all business can use retained profit as they won’t be making enough profit to be able to retain much.
What are the benefits of retained profit?
No interest has to be repayed.
What are the disadvantages of retained profit?
- Shareholders may object to using this source of finance as they may wish to receive the profit as dividends.
- The business may miss out of investment opportunities.
What are the 6 external sources of finance?
- Family and Friends
- Banks
- Peer-to-peer lenders
- Business Angels
- Crowd funding
- Other businesses
What are the advantage of using friends and family as a external source of finance?
- Family and friends may offer the money as a gift.
- May agree to flexible payment with little or no interest.
What are the disadvantage of using friends and family as a external source of finance?
- Amount of money available may only be small
- Borrowing can put a strain on the relationship, if they need the money back quickly.
What methods of finance do banks offer?
- Loans
- Overdrafts
- Mortgages
What are the advantage of using Banks as a external source of finance?
- Banks are recognised financial institutions, and the terms and conditions of their financial products are clear.
- Can also advise a business.
What are the disadvantages of using Banks as a external source of finance?
Strict lending criteria - can be hard for start-ups or other risky businesses to be approved for finance.
What is Peer-to-Peer (P2P) lending, and can you give examples?
Peer-to-Peer lending operates online, allowing individuals to lend money to others or businesses. Examples include Zopa and Prosper.
How does Peer-to-Peer lending work for lenders and borrowers?
Lenders specify how much they want to lend and their desired interest rate. Borrowers state how much they need, explain why, and provide the loan term. The lending company assesses risk and matches them.
What factors influence interest rates in Peer-to-Peer lending?
Riskier borrowers are charged higher interest rates, while overall, P2P loans often have lower rates than bank loans.
When might Peer-to-Peer lending be a good option for borrowers?
It is an attractive option if a bank has refused to provide a loan.
Who are business angels, and what do they do?
Business angels are wealthy individuals who invest money in new or innovative businesses they believe have the potential for success. They often provide advice and guidance as well.
What do business angels expect in return for their investment?
They ask for a share of the business, which may also give them some control over business decisions.
What is an advantage of working with a business angel?
Business angels often have extensive business knowledge and useful contacts that can benefit the business.
What are the challenges of finding and working with a business angel?
Finding a willing business angel can be difficult and time-consuming, and giving up a share of the business may result in a loss of control over decisions.
What is crowdfunding, and how does it work?
Crowdfunding involves raising money from a large number of people, usually via the internet. Each person contributes a small amount, but collectively enough can be raised to meet a large target.
Where do businesses typically present their crowdfunding ideas?
Businesses post their ideas on crowdfunding websites like Kickstarter, making details public so anyone can see and contribute.
What rewards might be offered to crowdfunding contributors?
Rewards can include early access to the product or the product at a discounted price upon release.
What is an advantage of crowdfunding?
Crowdfunding raises awareness of the business’s product or brand, potentially increasing sales even among those who do not contribute.
What are the risks of crowdfunding?
Risks include the business idea being copied since details are public, and potential damage to the business’s reputation if the idea fails, as many people would be aware of it.
Why might a business with a large retained profit choose to invest in another business rather than save the profit?
A business might invest in another business if bank interest rates are low, as saving the profit may not provide a good return.
What is a reason a business might offer finance to another business?
A business might offer finance to a business that aids its own success, such as investing in a supplier to improve the supplier-buyer relationship.
What might the business offering finance expect in return?
The business offering finance is likely to want shares in the other business, which may give them some control or influence over its decision-making.
How does the duration of finance needs affect the method a business chooses?
The length of time a business needs finance influences its choice of financing method, with short to medium-term needs leading to specific options.
What are some financing methods a business might choose for short to medium-term needs?
A business might choose an overdraft, leasing, grants, or trade credit for short to medium-term financing needs.
What is an overdraft?
An overdraft is when a bank allows a business to have a negative balance in its account.
What are the advantages of overdrafts?
Advantages include easy arrangement, flexibility, and only paying interest on the amount used.
What are the disadvantages of overdrafts?
Overdrafts have higher interest rates and may involve fixed charges, making them unsuitable for long-term use.
What is leasing, and when might a business choose this option?
Leasing involves paying monthly amounts to use an asset (like machinery or property) for a set period. Businesses choose leasing if they can’t afford to buy assets upfront.
What are the advantages of leasing?
Advantages include no large upfront payments and using up-to-date assets, sometimes with maintenance included.
What are the disadvantages of leasing?
Disadvantages include potentially higher long-term costs compared to buying outright.
What is hire purchase, and how does it differ from leasing?
Hire purchase is a type of lease where the buyer makes an initial deposit and pays the balance over time, with ownership transferring to the buyer at the end of the term.
What is a grant?
A grant is a fixed sum of money, often from the government, given for specific business projects.
What are the advantages of using a grant?
Advantages include no repayment or interest, and no share of the business is required.
What are the disadvantages of grants?
The application process can be long and competitive, and the business may not receive the money until the end of the project. Strict criteria must be met, or the grant may be retracted.
What is trade credit, and how does it help businesses?
Trade credit allows a business to buy goods or services and pay later, usually within 30-90 days. It helps with cash flow by delaying payments until after the product is sold or used.
What are the disadvantages of trade credit?
Disadvantages include missing out on early payment discounts, potential interest charges for late payment, and damage to the business’s credit rating if payments are missed.
What is a loan, and how is it typically paid back?
A loan is a fixed amount of money borrowed and paid back over a set period of time. The amount paid back depends on the interest rate and the length of the loan.
What are the different sources from which businesses can take out loans?
Loans can come from banks, family and friends, or peer-to-peer lenders.
What is required for a business to secure a loan?
Security, often in the form of property, may be needed in case the loan isn’t repaid. The lender can take possession of the property as payment.
What are the advantages of taking out a loan?
A business only needs to pay back the loan and interest, without giving up any ownership or share of the business profits.
What are the disadvantages of taking out a loan?
Loans can be difficult to arrange, especially if the business lacks assets for security, and loan providers may only lend money if they believe the business can repay it.
What is share capital, and how is it used by limited companies?
Share capital is money raised by selling shares in a private or public limited company. It is a long-term method of financing the business.
What are the advantages of financing through share capital?
Advantages include no repayment obligation and bringing in new expertise.
What are the disadvantages of financing through share capital?
Disadvantages include losing full ownership, shareholders expecting dividends, and potential influence over business decisions.
Why is selling shares not suitable for short-term finance?
Selling shares is costly and time-consuming, making it more appropriate for raising large sums of money rather than short-term finance.
What is venture capital, and who typically provides it?
Venture capital is funding for high-risk businesses with growth potential, often provided by business angels or professional investors known as venture capitalists.
What are the benefits of venture capital?
The business doesn’t have to repay the money and can benefit from expert advice.
What are the drawbacks of venture capital?
The business must give up a share of the business, and investors may want a say in its operations.
