3.1 Sources of Finance Flashcards
Role of finance for businesses
Sources of finance
- Basically where do we get money/capital/finance from?
In terms of people:
- Paying for bills, groceries, etc
- Buying fixed assets such as cars and houses
- Where do we get capital from?
- Income
- Loans
- Lease/rent
Types of expenditure
- Capital expenditure
- Purchase of fixed assets that will last more than 1 year
- E.g. buildings, machinery
- Revenue expenditure
- Spending on costs and assets lasting less than 1 year
- E.g. wages, rent, utilities, salaries, raw materials
Internal and External sources of finance
Internal
- Finance generated from within the business
- Personal funds, sale of assets, retained profit
External
- Finance generated from outside the business
- Loan capital, trade credit, business angel, overdraft etc.
Personal funds
Owner put their own savings into the company (Internal)
Retained profit
A company makes a profit, which they put back into the business rather than paying to shareholders as a dividend
(Internal)
Sale of assets
Selling physical and non-physical items that belong to the business
(Internal)
Share capital
Selling a part of the business to an investor
Loan capital
Borrowing money, usually from a bank, for a period of time. Interest is paid on the loan.
Overdrafts
When the bank allows your account to go negative for a short period of time (-$50)
Interest is likely to be very high
Trade credit
When a business delays paying its bills for goods and services after a period of time (rather than immediately). Usually 30 to 90 days.
Business angels
A wealthy individual who invests in the business
Venture capital
Organizations that are willing to invest in small businesses and start-ups with potential
Grants
Payments from the Government to a business for a specific purpose, usually for public benefit
Subsidies
Payments from the Government to a business to reduce their unit costs and encourage production
Debt factoring
When a business is owed money but sells the debt to a third party in return for immediate cash
Leasing
Obtaining the right to use an asset for a fixed period of time in return with regular payment
Short, medium and long-term finance
Short = less than 1 year
Medium = 1-5 years
Long = greater than 5 years
Overdrafts vs Loans
Loans
- Borrowing money, usually from a bank, for a period of time
- Interest is paid on the loan
Overdraft
- When the bank allows your account to go negative for a short period of time
- E.g. my account balance is 50 Euros
- I take out 100 and my balance is now -50
- Interest is likely to be very high
Purchase vs Lease
Pros of Purchase:
- No need to make regular payments - better for cash flow in the longer term
- Less expensive in the long term
- Own the asset so helps the Balance Sheet - e.g. could use the asset to obtain a loan (use it as collateral)
Pros of leasing:
- Better for cashflow now (short term) - no need to pay full cost immediately
- Do not pay for repair/breakdown costs
- Can replace for newer model when contract finishes
Debt vs Equity finance
Equity finance: Raise money by selling shares in your business, either to your existing shareholders or to a new investor.
Debt finance: borrowing money to be paid back at a future date with interest
What factors influence what type of source of finance a company should use?
Time period
- Short term lack of cash - overdraft
- Long term investment - loan or shares
Amount required
- Share capital can raise millions
- Harder to raise a large amount in a short period of time
Cost
- Look at interest rates
- IPO can cost millions in legal/consulting fees etc
Legal structure
- Sole trader and partnership cannot issue shares
Size of existing borrowing
- High debt limits future borrowing
Identify which source of finance might be suitable for the following situations
- Business A wants to automate production by purchasing a new machine for $100,000
- Loan capital
- Leasing
- Share capital (less possible)
- Business B is owed $2m by Walmart for goods they bought, but they are saying they cannot pay soon
- Debt factoring
- Extend trade credit with their suppliers
- Business C wants to expand the clothing business by opening 10 stores in Asia
- Share capital
- Venture capital
- Business D has run out of cash, none of the banks will lend them any money, they will go bankrupt tomorrow
- Sale of assets
- Overdraft
