3.2 External Sources Of Fiance Flashcards
Define external sources of finance + state examples
Comes from outside the organisation, typically from third-party providers. Businesses use external finance when they cannot generate sufficient funds internally.
- share capital
- loan capital
- overdrafts trade credit
- crowdfunding
- leasing
- micro finance providers
- business angels
Define share capital / equity capital
= finance raised by a limited liability company through the sale of shares on a stock exchange.
It is a long-term source of finance that does not need to be repaid, but it dilutes ownership and may require dividend payments to shareholders.
Evaluate share capital
✅ no repayment required
✅ No interest payments – reduces financial burden.
✅ ⬇️ reliance on debt
✅ Can raise large sums of money – useful for expansion
❌ Dilution of ownership and control.
❌ Dividend payments may be required – affects retained profits.
❌ High cost of issuing shares, especially IPOs.
❌ Strict regulatory compliance for public companies.
Define loan capital / debt capital
= borrowed funds from financial institutions, such as banks, used to finance business operations or purchase long-term assets. It must be repaid with interest, making it a more expensive source of finance.
Evaluate loan capital
✅ Repayable in instalments – reduces financial strain.
✅ Lower interest rates for large businesses – economies of scale.
✅ Owners retain control – no dilution of equity.
❌ Interest payments required – increases costs.
❌ Collateral may be required – risk of asset seizure.
❌ Variable interest rates can increase costs unpredictably.
Define overdrafts
= a short-term banking service that allows businesses to withdraw more money than is available in their account, up to a pre-approved limit, to cover short-term liquidity needs.
Evaluate overdrafts
✅ Quick and easy to arrange.
✅ Flexible – only used when needed.
✅ Useful for short-term cash flow problems.
❌ High interest rates – more expensive than loans.
❌ Limited borrowing amount.
❌ Repayable on short notice.
Define trade credit
allows businesses to purchase g.&.s. from suppliers and pay for them later, typically within 30 to 90 days. This helps businesses manage cash flow effectively.
Evaluate trade credit
✅ No interest if paid within the agreed period.
✅ Helps improve cash flow and working capital.
✅ Suppliers may offer discounts for early payments.
❌ Delayed payment could harm supplier relationships.
❌ Failure to pay on time may result in penalties or loss of credit terms.
❌ Limited to businesses with a good credit history.
Define crowdfunding + start 2 types
= a method of raising finance by collecting small amounts of money from a large number of people, usually through online platforms, to fund a business project.
Types of Crowdfunding:
• Equity crowdfunding – investors receive a stake in the company.
• Donation-based crowdfunding – supporters donate money without expecting financial returns.
Evaluate crowdfunding
✅ Avoids traditional bank loans + their requirements
✅ Can raise significant finance from many small investors
✅ No ownership dilution in donation-based crowdfunding
❌ Legal and transparency requirements increase costs.
❌ Intellectual property theft risks if business ideas are shared.
❌ Potential for crowdfunding scams.
Define leasing
= an agreement where a business rents non-current assets, such as machinery or vehicles, from a leasing company for an agreed fee, rather than purchasing them outright.
Evaluate leasing
✅ No large upfront capital expenditure required
✅ Maintenance costs are covered by the lessor
✅ Flexibility – suitable for short-term asset use
❌ Lessee never owns the asset
❌ Long-term leasing can be more expensive than purchasing outright
Define microfinance providers
are financial institutions that offer small loans to low-income individuals or entrepreneurs who lack access to traditional banking services, helping them become financially independent.
Evaluate microfinance providers
✅ Helps reduce poverty and unemployment.
✅ Empowers small business owners, especially women.
✅ Creates wider social benefits, such as better healthcare and education.
❌ High interest rates due to small loan amounts and high risks.
❌ Limited in scale – not enough to significantly impact the economy.
❌ Risk of borrowers falling into debt if businesses fail.
Define business angels
wealthy private individuals who invest their own money in high-potential start-ups or small businesses in exchange for equity or future profit shares.
Evaluate business angels
✅ Provides crucial finance for start-ups.
✅ Access to mentorship and industry expertise.
✅ No repayment burden, unlike loans.
❌ High-risk investment – no guaranteed returns.
❌ Difficult to secure funding due to high competition.
❌ Dilution of ownership and control.
Define Initial Public Offering
when a company sells its shares to the public for the first time on a stock exchange to raise share capital
Define interest rate
cost of borrowing money or the reward for saving money, expressed as a percentage.
Define gearing ratio
proportion of a company’s finance that comes from debt compared to equity. A high gearing ratio means more reliance on loans, whereas a low gearing ratio means more reliance on share capital.
