3.2 Sources of Finance Flashcards
internal sources of finance
money raised from a business/ owner’s existing assets
(money business or owner previously earned)
three main internal sources of finance
personal funds
retained profit
sale of assets
personal funds
money invested by the owner of a business
benefits for shares of a business
- right to future dividends
- power to make business decisions
Retained Profit
aka accumulated profit
money company has left at the end of the trading period after all costs, expenses, dividends and taxes
disadvantages for retained profit
may take years before funds accumulate and are sufficient
loss of dividends
advantage for retained profit
doesn’t have to be repaid
personal funds advantages
doesn’t have to be repaid
owners receive shares in return for their investment
personal funds disadvantages
may be lost in case of bankruptcy
sale of assets
selling something a business owns (asset)
tangible (ie land, machinery) or intangible (ie patents, brand names)
opportunity costs
potential cost of missing an opportunity by choosing an option over another
(good to update technology; sell old, buy new)
(good when business changes objectives)
short-term sources of finance
repaid within 12 months
medium-term sources of finance
longer than one year but less than 5 years
(ie bank loan, leasing and subsidies)
long-term sources of finance
longer than 5 years
(ie equity finance, mortgages)
characteristics of personal funds (length, costs, loss of control, suitable for:)
long, medium and short-term finance
opportunity cost
no loss of control
small businesses with large funding needs
characteristics of retained profit (length, costs, loss of control, suitable for:)
long, medium, and short-term
opportunity costs.
Loss of dividends to shareholders.
no loss of control.
all businesses.
characteristics of sale of assets (length, costs, loss of control, suitable for:)
depends on size of asset
opportunity cost
no loss of control
potentially all businesses
external sources of finance
equity finance
debt finance
(other)
equity finance
provider receives part ownership of the business in exchange for the finance
equity finance advantages
no repayments, no interest
risks associated are shared among many owners
equity finance disadvantages
loss of control
loss of a portion of future dividends
three types of equity finance
business angel
venture capital
share capital
business angel
successful, wealthy business person who invests their money into new businesses
private individuals who risk their own money
(very early finance)
in return for their investment and guidance, they require part ownership of the business and a portion of future profits
seek high growth and large returns on investment – mentor entrepreneurs (expertise and contacts)
disadvantage of business angels
the BA might want the business to be set up or grown differently from the entrepreneur
the BA and the entrepreneur must share the same values and objectives
venture capital
pools resources from a group of investors to fund a new business
venture capitalists are companies which use the money from their clients to fund investments
aim: help business grow so that the investors can later sell their stake at a higher price
share capital
money raised through the issue of shares to new investors on a stock market
(in an IPO, the business becomes a public limited company – shareholders receive a portion of profits (dividends))
Debt finance
money borrowed from a bank (or other financial institution)
interest rate payed to the lender
forms of debt finance
loan capital
overdrafts
microfinance
trade credit
loan capital
financing borrowed by a business from a financial institution, to be repaid with interest
loan
medium or long-term source of finance (usually used to buy fixed assets)
mortgage
type of long-term loan used to purchase lands or buildings
collteral
asset offered to a lender in the event that the business doesn’t repay the loan
advantage of loan capital
money available immediately
repaid in small chunks, over a period of years
overdrafts
high-cost, short-term loan attached to a bank account
(account holder can withdraw an amount of money that is greater than they currently hold)
very high interest rate
microfinance
providing financial services to individuals who have limited income and assets and cannot get money from the bank
microcredit
subset of microfinance
small loans that enable someone to start or continue to finance a small-scale business
no collateral
short loan period
high interest rate
trade credit
receiving goods and services from a supplier immediately, but paying it back at a later date
no interest
leasing
renting a fixing asset over a period of time, instead of buying it
advantages to leasing
can use an asset without having to fully finance it
can lease the latest model and return the asset when the business no longer needs it
no worry about maintaining or repairing the equipment – lowers costs
crowdfunding
many people invest small amounts of money to fund a project/ business
peer-to-peer lending (crowdfunding)
many investors provide a loan that earns interest
equity crowdfunding
many investors acquire a small share of ownership in the business
rewards-based crowdfunding
many investors receive non-financial reward at a later date, ex. good or service produced by a business
donation-based crowdfunding
participants are donors rather than investors and don’t receive anything in return
types of crowdfunding
peer-to-peer
equity
rewards-based
donation-based
patient capital
long-term financing where investors wait longer to see returns and expect a fair return
loan capital advantage
no loss of ownership and control of business
loan capital disadvantage
burden of repaying is more concentrated
larger risks
interest – loan can be more expensive
