3.5.3 Making Financial Decisions: Sources of Finance: Internal and External Sources of Finance. Flashcards
What are the methods of raising finance from within a business?
Retained profit and debt factoring.
Define an internal source of finance.
Ways of raising finance from within the business, such as retained profit or debt factoring.
Define an external source of finance.
Ways of raising finance from outside the business, such as loans and overdrafts.
Define short term.
Describes finance that is normally intended for repayment in 12 months.
Define long term.
Describes finance that is normally intended for capital expenditure and where repayment, if necessary is due after three years or more.
What are the types of spending that finance are used to explore?
Capital expenditure.
Revenue expenditure.
What is capital expenditure?
Spending on items that can be used time and time again such as (fixed or non-current assets) such as machinery.
What is revenue expenditure?
Spending on current day to day costs such as the purchase of raw materials.
What are examples of short term finances?
Debt factoring.
Bank overdraft.
What are examples of long term finances?
Retained profit.
Ordinary share capital.
What is debt factoring?
An internal source of short term finance. A company buys the rights to collect money from the credit sales of a business.
What are the advantages of debt factoring?
Improved cash flow in the short term.
Lower administration costs.
Reduced risks of bad debts.
What are the disadvantages of debt factoring?
Loss of revenue.
High costs.
Customer relations problems.
What is an overdraft?
When a bank allows an individual or organisation to overspend its current account in the bank up to an agreed (overdraft) limit and for a stated period of time.
What are the advantages of bank overdrafts?
Flexible.
Interest is only paid on the amount of the overdraft being used.
Particularly useful to seasonal businesses.
What are the disadvantages of bank overdrafts?
Level of interest rate charged.
Flexible interest rates.
Banks can demand immediate repayment.
Paperwork demands.
Define retained profit.
The part of a firms profit that is reinvested in the business rather than distributed to shareholders.
What are the advantages of retained profit
Cheap source of finance.
No security required.
Independence and confidentiality.
Shareholder goodwill.
What are the disadvantages of retained profit?
Impact of dividends to shareholders.
Misuse of funds.
Possibility of overcapitalisation and ineffective use of funds.
Opportunity cost.
What is share capital?
An external source of long term finance.
What is ordinary share capital?
Money given to a company by shareholders in return for a share certificate that gives them part ownership of the company and entitles them to a share of the profits.
What are the features of ordinary share capital?
Aka risk capital or equity capital.
Appeals to investors prepared to take a risk - liquidation - cannot pay its debts.
Aka permanent capital as it a business will always have shareholders who will own shares and will never have to repay these shares.
What are the advantages of ordinary share capital?
Limited liability encourages shareholders to invest.
Not necessary to pay a dividend.
Bringing new shareholders into a small business can add further expertise.
Ordinary share capital is permanent.
What are the disadvantages ordinary share capital.
Possible high dividend payments.
Conflict of objectives.
Loss of control of original owners.
Define loan capital.
Money received by an organisation in return for the organisations agreement to pay interest during the period of the loan and to repay the loan within an agreed time.
What type of finance are loans?
External source of long term finance.
Who are the providers of loan capital?
Creditors.
What are the advantages of loans?
Easy for budgeting.
Lower interest rates.
Designed to meet the company’s needs.
What are the disadvantages of loans?
Limitation on amount available.
Inflexibility.
Potential expense.
Define venture capital.
Finance that is provided to small or medium sized firms that seek growth but which may be considered as risk by typical share buyers or other lenders.
What type of financing is venture capital?
An external source of long-term finance.
What forms can venture capital take?
Loans or payment in return for share capital.
Or a mixture between the two.
What are the advantages of venture capital?
Suited to high risk companies.
Venture capitalists sometimes allow interest or dividends to be delayed.
Source of advice and contracts.
What are the disadvantages of venture capital?
Giving up some ownership of business.
Possible high finance costs.
Excessive influence.
What are other sources of short term finance?
Sale and leaseback. Both internal sources of finance.
Immediate cash from selling off a property the business owns and then renting it back from the new owner.
What are other sources of long term finance?
Debentures.
Mortgages.
Sales of assets.
Personal sources.
What are the factors influencing how to choose the source of finance.
Legal structure of the business.
Use of the finance.
Amount required.
Firms profit levels.
Level of risk.
Views of the owners.
