3.2 sources of finance Flashcards
what are sources of finance?
various ways that a business gets its money in order to run the business
what are the 2 ways sources of finance can be classified
internal sources and external sources of finance
what are the three types of internal sources of finance?
personal funds (for sole traders & partnerships), retained profit, the sale of assets
what are internal sources of finance?
finance that comes from within the organization from its own resources without the help of a third party. do not have to be repaid to anyone as they belong to the organization or owner
what are personal funds
sole traders and partners usually rely on personal funds from their own savings to finance their start up businesses.
advantages of personal funds?
shows commitment to investors, money doesn’t have to be paid back, no interest is paid
disadvantages of personal funds
its a great risk for sole traders and partners because the amount needs to be large to start and maintain the business
what is profit?
profit exists when a firms total revenue exceeds its total costs.
what is retained profit?
money left in the business after all expenses have been paid including taxes to the government and dividends to. shareholders. It is money that is reinvested back into the business. Retained profit are a firms savings that have been built up over time. for established business its the primary source of investment income
advantages of retained profit
no interest charges, permanent and does not need to be repaid, flexibility in the use of retained profit
disadvantages of retained profit
start ups or struggling businesses will not have retained profit, less dividends are paid out to shareholders
what is an asset?
anything that a business owns and has a marketable value like buildings, vehicles or computers
what are sale of assets?
is when an established business sells unwanted items like machinery, old stock, land or buildings to fund other projects. companies may decide they do not need to own an asset so they well sell it and lease it back this is knowns as sale and lease back
what are the 8 external sources of finance?
share capital, loan capital, overdrafts, trade credit, crowdfunding, leasing, microfinance providers, business angels
what are external sources of finance
finance that comes from outside the organization, usually with the help of a third party. only used when a business is unable to get enough funds from internal sources due to high costs
what is share capital
(also known as equity capital) is finance raised through the issuing of shares via a stock market exchange (stock market). It is a long term source of finance for limited liability companies
what is an IPO? (related to share capital)
when a company sells its shares for the very first time on the stock market
advantages of share capital?
permanent finance and doesn’t need to be repaid, cheaper than a loan because there’s no interest, can raise large amounts of money
disadvantages of share capital
needs to pay shareholders dividends, could lose control and ownership of company, can only be done by publicly held and privately held companies (private can only sell to current shareholders)
what is loan capital
(known also as debt capital) borrowed funds from financial lenders such as commercial banks. Long term source of finance. it doesn’t appear as part of a firms non current liabilities. typically used to purchase non current assets such as machinery and property. loans for property are called mortgages. interest is charged on the loan, loan payment is usually paid monthly
advantages of loan capital
arranged quickly, owners still have full control, repayment is spread out over time, exact amount needed can be borrowed
disadvantages of loan capital?
interest is charged on loan, repayments must be made even if the company isn’t making money, some businesses might find it difficult to get a loan
what is overdraft?
banking service that enables costumers to withdraw more money from their account than what exists in the account (up to a certain amount). helps businesses meet their short term liquidity needs especially in emergency situations. Overdraft has to be pre approved to avoid extensive bank charges
advantages of overdraft
very flexible source of finance only used when needed, good for short term cash flow problems, only pay interest in the amount of the overdraft
disadvantages of overdraft
must pay interest in the amount overdrawn, small amount to keep a business functional, bank can ask for the money at short notice, usually high interest rates
what is trade credit
agreement between businesses that allows the buyer of goods or services to delay payment to the seller and pay them at a later date. The credit period offered is usually from 30-60 days.
advantages of trade credit
do not need to pay interest, helps businesses that struggle with cashflow
disadvantages of trade credit
may lose discounts for not paying quickly or in cash, can cause conflict with supplier if payment is delayed
what is crowdfunding?
involves raising small amounts of money from a large number of people to fund a particular business project. Done using online platforms. supports are known as crowd and business entity referred to fundraiser
advantages of crowdfunding
provides acces to thousands of investors who can interact with the campaign, business maintains full control, available to businesses that have been turned down by banks
disadvantages of crowdfunding
many businesses do crowdfunding so its hard to stand out, lots of regulations to post on the platform, fees are paid to the hosting website
what is leasing
when a business enters a contract with a leasing company to use particular assets such as machinery, equipment, or property. allows a firm to use an asset without having to purchase it. the business never owns the item
advantages of leasing
leasing company responsible for the repairs and maintenance, useful for when assets are only required for short periods of time
disadvantages of leasing
leasing can be more expensive than purchasing, asset does not belong to business, can only be used for certain items
what is microfinance providers
for-profit social enterprises that offer a financial service to those without a job or on very low incomes. these members of society would not ordinarily be able to secure bank loans. help entrepreneurs or women struggling to finance their business start ups to gain access to loans of a small amount. can give people the opportunity to become self sufficient and empower them to run their business.
advantages of microfinance
helps empower entrepreneurs of small businesses, loans are given out quickly and without as many formalities as a traditional bank
disadvantages of microfinance
the amount of borrowing is small, interest is charged (although typically lower than commercial banks), increases the debts of entrepreneurs
what are business angels?
wealthy and successful private individuals who risk their own money in business ventures that have a high growth potential in return for ownership equity. focus on helping businesses succeed by using their extensive business experience.
advantages of business angels
provide essential source of finance for start ups and small business who cannot get loans from banks or raise their own finance, benefit from the expertise and experience of the business angels
disadvantages of business angels
take some control away from the owner of the business, angel investor will also want a say in business operations, not easy to secure due to the high risk involved and competition from other entrepreneurs
limit of short term finance
finance lasts for one year or less
limit of long term finance
duration from 5 to 30 years
publicly traded companies can use
selling shares (share capital) to obtain capital meanwhile sole traders can’t
a large business tends…
to have more retained profit
who is it easier to get approved for a bank loan
a large business
loans for property are called
mortgages
if finance is needed for the purchase of a new factory or office buildings then…
then long term sources of finance are needed like mortgages (loans for property)
when does the sale of assets be appropriate
would be suitable if they want to upgrade their non current assets
what type of finance can be used for the day to day running (short term)
trade credit and overdraft
when can business angels be appropriate
if the business has high earnings potential
when is loan capital appropriate
when the organization faces a major liquidity issue so it needs access to large amounts of money especially if they can’t get money owed by debtors
when do you use short term finance
when business needs small amount of money. (overdrafts)
when do you use Long term finance
for large amounts of money. (use loan capital, mortgages, share capital)
Is an IPO expensive
yes, unlike personal funds or retained profit
is leasing expensive
in the long term yes. it is cheaper to buy the assets
are mortgages expensive
yes it can add lots of costs for the business
higher interest rates make
loan capital, overdraft, bank loans and mortgages more expensive
which sources are long term
retained profits, loan capital, crowd funding, microfinance, business angels, share capital, leasing
which sources are short term
retained profits, overdrafts, trade credit
what type of finance is not available due to the legal structure of sole traders
share capital, bank loans
what type of finance is not available due to the legal structure of partnerships
share capital
what type of finance is not available due to the legal structure of privately held companies
personal funds, microfinance
what type of finance is not available due to the legal structure of publicly held companies
personal funds, business angels, microfinance, crowdfunding
