3.1 Sources of finance Flashcards
Role of finance for a business
- capital expenditure
- revenue expenditure
Capital expanditure
Finance spent on fixed assets (assets that are purchased for long-term use and are not likely to be converted quickly into cash, such as land, buildings, and equipment). Fixed Assets determine the scale of a firm’s operations; they are not intended for resale (in the ST) but for the purpose of generating money for the business.
Revenue expenditure
Payments for the daily running of a business; wages, raw mat, rent and electricity. This also includes the payment of indirect costs; insurance and advertising. In order for a business to generate enough revenue to earn a profit, cost must be controlled.
Profit
Revenue minus all company expenses.
Revenue
Money made from sales.
Internal sources of finance
- personal savings
- retained profit
- sale of assets
Personal savings (sources of finance)
Money coming from the owner.
Retained profit (sources of finance)
Part of the profit kept back in the business for reinvestment. Ploughing retained profits back into the business is inexpensive and a significant source of expansion finance.
Sale of assets
An established business may sell buildings, machinery or even subsidiaries to generate cash if they are not fully used or profitable. In addition, firms may sell assets they still need but do not necessarily need to own, e.g. firms may sell expensive offices in city centres and then lease them back for an extended period (‘sale and leaseback’). In a liquidity crisis, firms may be forced to sell assets they do need.
External sources of finance
- share capital
- loan capital
- overdrafts
- trade credits
- grants
- subsides
- debt factoring
- leasing
- venture capital
- business angels
Share capital (sources of finance)
Money coming from selling shares.
Loan capital (sources of finance)
Money obtained by taking a loan, bank or other third party.
Overdrafts (sources of finance)
When bank allows to spend more money than are in the account.
Trade credits (sources of finance)
Getting product without paying upfront.
Delayed payment (30,60,90 days).
Grants (sources of finance)
Money given from government organizations for a specific purpose.
Subsidies (sources of finance)
Money form the government to enhance the business (if business is needed for the society).
Dept factoring (sources of finance)
Selling the debt on for a percentage (to a debt collection company).
Leasing (sources of finance)
Renting property.
Ventrue capital
Capital invested in a project in which there is a substantial element of risk, typically a new or expanding business.
Venture Capitalists, seek to invest in a small to medium-sized businesses that have high growth potential.
Business angels
Wealthy individuals how choose to use their own money to invest in a business with growth potential.
Short-term finance
The short term means a period of less than one year. There are three main sources of short-term external finance: bank overdrafts, trade credit and debt factoring.
Medium-term finance
The medium term is normally used to denote a one to five-year time period. There are two main sources of medium-term external finance: leasing and medium-term bank loans.
Long-term finance
The long-term denotes a time period of over five years. The two main choices are between debt or share (equity) finance. Sources of long-term external debt finance include:
- loan capital/long-term bank loans
- share capital/equity finance
- government grants and subsidies
- venture capital
- business angels
Considerations when selecting a source of finance
- Cost: administration or interest charges.
- Purpose: revenue expenditure tends to be financed by short-term finance, whereas capital expenditure is financed by long-term finance.
- Amount of finance required.
- Financial situation: firms suffering liquidity problems will find borrowing difficult and expensive.
- Status and size: small firms lack sources as they lack security.
- Time: how long the finance is required.
