3.5.3 SOURCES OF FINANCE

Question 1

debt factoring (external source of finance)

Answer 1

The process of selling debts owed to a business to a financial institution.
-The business may receive funds immediately but at a reduced rate.
(i.e may only receive 80% of the total value of debt.)
After the debt has been paid the business will receive further payment but the financial institution will keep a percentage of the payment as a fee.

Question 2

ads of debt factoring

Answer 2

-receives large amount of debt immediately (80%)
-good source of short term finance to address cash flow problems.
-debts are chased by experts, saving managers time
-reduces risk of bad debts

Question 3

disads of debt factoring

Answer 3

-reduces profitability of a firm as a result of the fee paid to the financial institution.
-may damage reputation of firm as they are seen to be in need of short term finance.

Question 4

Overdrafts (external source)

Answer 4

The facility to overspend on a current account up to an agreed sum.
The business in affect can withdraw money from account that is not there, meaning they go overdrawn. “in the red”.
-Interest is charged on the overdrawn amount.
-good short term source of finance.
-provided by banks & building societies (external)

Question 5

ads of overdrafts

Answer 5

-only pay interest when actually used
-only pay for money borrowed
-quick and easy to arrange
-no charges for paying off overdraft

Question 6

disads of overdrafts

Answer 6

-bank can call it in at any time
-only available from current bank account
-interest payments tend to be variable making it more difficult to budget(tend to be very high)
-banks secure the overdraft against the business’ assets

Question 7

Loans (external source)

Answer 7

A set amount of money provided for a specific purpose, to be repaid with interest over a set period of time.
May be secured against an asset and if there is a default on repayments, the asset can be taken.
More suitable for long term projects, however this will depend on the size of loan and repayment period.

Question 8

ads of loans

Answer 8

-quick & easy to secure, can be done online
-fixed interest rates, firms can budget
-can be used to improve cash flow (longer term)
-borrower retains ownership of company
-it is a contract between 2 parties (borrower & a bank) it is an equal contract

Question 9

disads of loans

Answer 9

-interest must be paid regardless of financial performance
-a firm that is highly geared ( finance mostly by debt and loans) then this may be seen as high risk
-firm normally provides security known as collateral.
-more expensive than other forms of finance, depending on interest rates
-can be charged a penalty for early payment

Question 10

Retained profit (internal source)

Answer 10

Profit kept within business from profit for the year, help finance future activities.

Question 11

ads of retained profit

Answer 11

-no interest to pay
-doesn’t dilute business ownership

Question 12

disads of retained profit

Answer 12

-only an option if sufficient retained profit exists within business.
-if retained profit is used there may be nothing left if crisis happens, or new opportunities arise
-shareholder dissatisfaction if this is at expense of dividends.

Question 13

Share capital

Answer 13

Finance raised through selling of shares.
Form of equity capital. i.e shareholder becomes a part of owner of business.
Shareholder will be rewarded for their investment by the payment of dividends, but also may benefit from increase in share price, increasing value of their shares.
(only option for incorporated business like PLC, Ltd)

Question 14

ads of share capital

Answer 14

-only need to pay dividends if profit is being made and amount of dividend is not fixed
-possible to raise large amounts of finance
-no interest repayments

Question 15

disads of share capital

Answer 15

-loss of ownership, shareholders are part owners
-potential risk of loss of control for plc, threat of hostile takeovers
-complex & costly process of issuing shares, especially for PLC.

Question 16

Venture capital

Answer 16

Investment from an established business into another business in return for a percentage of equity in the business.
also known as ‘private equity finance’
-venture capitalists will normally look for high rates of return in a specific time period.
-the business/entrepreneur may also benefit from expertise and mentoring from venture capitalist
-associated often with high risk start ups

Question 17

ads of venture capital

Answer 17

-potential for large sums of money for investment
-expertise to help business
-makes easier to attract other sources of finance
-provides required capital for expansion

Question 18

disads of venture capital

Answer 18

-long and complex process
-expert financial projections likely to be required
-initially expensive for firm
-partial loss of ownership
-risk of conflict or perceived interference.

Question 19

Crowdfunding

Answer 19

-involves raising finance from a large number of people each investing different, often small, amounts of money.
-business uses internet to explain how much money is required, how it will be used and exit strategy stating predicted return on the investment.
-investor is only tied into their promised contribution if total amount is raised.

Question 20

ads of crowdfunding

Answer 20

-often used when finance can’t be raised elsewhere i.e a bank loan.
-large amounts of money can be raised if enough people are interested.

Question 21

disads of crowdfunding

Answer 21

-often not successful
-business may not raise enough cash, therefore will pursue different source of finance.

Question 22

Factors to consider when choosing finance:

Answer 22

~legal structure (plc, ltd, sole trader)
~how profitable is the business (i.e retained profit)
~current interest rate-particularly with bank loan
~duration/flexibility
~purpose of loan