5.3 Sources of finance

Question 1

Types of internal sources of finance

Answer 1

• Personal savings
• Retained profit
• Selling assets

Question 2

Personal savings

Answer 2

• Invested by the owner of the business
• Relevant for start-up businesses, entrepreneur has saved up to fund business venture
• Very risky

Question 3

Retained profits

Answer 3

• The profit that the business has effectively saved whilst it has been operating
• Cheap (no interest)
• Limited (can only spend profits that have been saved)
• May not be high enough to fund big, long-term projects

Question 4

Selling assets

Answer 4

• A business can sell buildings or machinery that they do not use
• Cheap (no interest)
• Selling assets can harm a business’ operations

Question 5

External sources of finance

Answer 5

• Hire purchases
• Bank loans / mortgages
• Share capital
• Loans from family or friends
• Government grants
• Trade credit
• Debt factoring
• Venture capital
• Overdraft

Question 6

Hire purchases

Answer 6

When a business buys something and instead paying for it upfront pays for it in instalments
- helps to buy things like machinery

Question 7

Bank loans / mortgages

Answer 7

Borrows money from bank and pays interest
- harder = seen as riskier

Question 8

Share capital

Answer 8

Selling shares to other people or businesses - % of the business in return for getting finance invested in the business

Question 9

Loans from family or friends

Answer 9

Start-ups often use loans because the entrepreneur doesn’t have enough personal savings to finance the investment

Question 10

Government grants

Answer 10

A government may give grants to businesses to research things that the government is interested in

Question 11

Trade credit

Answer 11

Businesses pay suppliers at a later date. It involves buying something now and paying it for later

Question 12

Debt factoring

Answer 12

Selling debt to a third party business
- will gain cash immediately rather than wait for debts to be settled although the business will sell its debt for less than its original value
- the third party that buys this debt will then arrange and organise invoices and ensure that the debt money is collected. The third party business will retain a fee to cover the costs of its debt collection service

Question 13

Venture capital

Answer 13

Involves investors, venture capitalists providing a business with loans and share capital which is usually to support business growth
- will often ask for some control of the business they are investing in and this can be through the issue of shares or through the appointment of venture capitalists as non-executive directors of the business

Question 14

Overdraft

Answer 14

Offered by banks allowing businesses to borrow an amount of money up to a limit which has been agreed in advance
- Flexible: borrow as much as it wished provided that the amount stays within an agreed limit
- Often pay for this flexibility through higher interest rates

Question 15

What factors affect what is the best source of financing

Answer 15

• Cost
• Long-term vs Short-term
• Financial situation
• New vs established business