5.3 Sources of finance

Question 1

define: Internal sources of finance

Answer 1

exists within the business

Question 2

define: External sources of finance

Answer 2

injections of funds into the business from individuals, organisations or financial institutions

Question 3

define: Short term sources of finance

Answer 3

finance that is needed for a limited period of time (less than 1 year)

Question 4

define: Long term sources of finance

Answer 4

finance that is needed for an extended period of time (more than 1 year)

Question 5

Sources of Finance:

Answer 5

1. Retained profit - reinvesting profit
2. Overdraft - borrow a small agreed limit from the bank
3. Debt factoring - selling bills that have not yet been paid
4. Bank loan, mortgages
5. Debentures - long term, fixed rate of interest, secured against assets
6. Venture capital - business angels
7. Sale of assets - selling machines etc that the business owns
8. Share capital - selling a % of the business

Question 6

Overdrafts:

Answer 6

• Agreed limit of borrowing for an agreed amount of time
• Flexible form of finance as amount can vary as long as it is within the boundaries
• Usually easy to increase /decrease the amount with limited forms
• Overdrafts can have high interest rates if you go over the agreed limit or use for longer than you should (usually around 4-6%)
• If the business stays within the agreed limit of cash / time period the rate of interest is often very low, sometimes even 0%

Question 7

Debt Factorimg:

Answer 7

• Bills that are yet to be paid, the business sells for cash
• Whoever the bill is sold to will then recover that money
• Gives the business an immediate cash boost
• Won’t be the full amount as the middle party will need to make a profit

Question 8

Bank Loans, Mortgages, Debentures:

Answer 8

• Bank loan will be provided as long as the business has a secure financial position, past and present
• The more risky the loan is, the higher the rate of interest
• Banks usually charge 2% over their base rate of interest (can be fixed or variable)
• Mortgages - long term loans repaid over periods of up to 50 years, used to purchase property
• Debentures are long term, to be paid at some point in the future (sometimes 15 years), interest rates are fixed, can be a permanent loan (irredeemable debenture), often secured using non current assets as collateral
  (All england lawn tennis club issued debentures to help fund improvements at Wimbledon. Tennis fans are very pleased because the deal includes tickets.)

Question 9

Retained Profits:

Answer 9

• Using profits from the current trading year or previous years
• Businesses can then use this money to reinvest
• Avoids them paying interest on a loan
• May avoid the need for the business to sell shares to raise finance
• There will be opportunity costs - shareholders may not be happy with reinvesting if they receive lower dividends, could be earning interest in a bank account
• This is only available for firms that are actually making a profit and it is sufficient to purchase expensive capital

Question 10

Share capital / Equity capital:

Answer 10

• Selling a % of your shares to raise finance
• The shareholder gets the benefit of dividends

Which type of ownership structures can do this?
PLC and Ltd

Which is it easier for and why?
PLC because they can sell their shares on the stock exchange

They do not need permission from the other shareholders like Ltds do

• can potentially avoid paying dividends if they aren’t profitable
• are at risk of losing control

Question 11

Venture Capital:

Answer 11

• Normally a mix of a loan and share capital
• Someone will invest in the business but will want a say in how things are run
• Financial institutions offer these services as well as individuals
• Can provide experience as well as funds
• Venture capital will not advance huge amounts to the business, it is not usual for the lending to exceed £500,000

Question 12

Sale of Assets:

Answer 12

• Selling assets they no longer require - Normally these are non current assets (which are: Land, buildings, vehicles etc)
• No interest and shareholders don’t tend to suffer dilution of control
• The business would however lose access to the asset it has sold
• If the business is likely to need the asset in the future, they could sell and lease back
• The business now has to pay for assets that were once free to use

Question 13

Other sources of finance:

Answer 13

• The internet and social media has played a major role in the development of new sources of finance
• Businesses can directly appeal with lots of people for funds
• > Go fund me
• > Crowdfunding