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.