8: Raising Finance Flashcards
Internal sources of finance
Finances raised from within the business.
- Owners savings (for unincorporated businesses)
- Retained earnings
- Retained profit and income from a sale of assists of the business.
Personal sources of finance
Its very rare that a small business start-up doesn’t require some investment from the owner. So the most important source of fin ace is the owner’s own money.
Some entrepreneurs will borrow from friends and family.
Advantages of personal sources of finance:
- No cost to using this money, in terms of interest costs.
- A sign of confidence if entrepreneur is putting own mine in. If they’re willing to put their own money at risk, maybe others will as well.
- Doesn’t can to worry about money being withdrawn, which could happen if the money was borrowed.
- Theres no risk of interference in decision making by a lender.
- The entrepreneur doe not have to pay out anything from profits if he/she does not want to, its all available to reinvesting.
- Borrowing from friends or family means its rare for interest to be paid.
- Friends and family are more willing to lead than other lenders.
Disadvantages of person sources of finance:
- Not strictly true theres no cost to an owner using his/her own money. Theres the OPPORTUNITY COST in terms of the alternative uses in which the money could have been used.
- Most entrepreneurs have limited finance at the start, which limits what the business can purchase.
- New business start-ups are risky, so the entrepreneur could lose everything if the business is not a limited company.
- Borrowing from friends or family can cause strain on relationships if the business does not do well.
External sources of finance
Those that are outside the business, such as banks and shareholders.
Overdraft
A temporary arrangement which allows the business to draw out more money than is in its account, up to an agreed limit.
Advantages of an overdraft:
- It is a flexible source of finance, because it is only used when it is needed.
- It is quick and easy to arrange.
Disadvantages of an overdraft:
- It is expensive if used for a long period of time or for large amounts.
- Arrangement fees and fees for going over the overdraft limit can be high.
- The overdraft can be removed at short notice.
- The business has to have a bank account with that bank in order to get an overdraft.
Loan
A loan is a sum of money lent for a fixed period of time, repaid over an agreed schedule.
A good source of finance for assets such as machinery and equipment and other start up costs.
Advantages of a loan:
- The length of the loan can be matched to the length of the need for the loan. The business can them plan for the repayments.
- The interest is fixed for the period of the loan, so it is easier to budget for the loan.
- The loan is guaranteed for the period, so the business knows it has got the money.
- There is no need to give the lender a proportion of the profits earned by the business.
- The lender does not have any say in how the business is run.
Disadvantages of a loan:
- Interest is paid regardless of wether the business is making a profit or not.
- The loan may have to be secured against a personal asset or an asset of the business, placing it at risk if the business cannot keep up the payments.
- The length of the loan may turn out to be longer than the life of the asset purchased with it. This means the business is paying for something it no longer needs.
Share capital
Another source if finance is to ask an investor to put money into a company in return for a share of the business.
People who invest share capital aren’t entitled to regular interest payments. They may, however, receive a proportion of any profit the business makes at the end of the year in the form of dividends.
Other big difference between share capital and loan capital is that share capital is never paid back, so it is best used for very long term purposes.
If a business has a lot of growth potential, or is seeking to grow rapidly, it may look for investors such as venture capitalists or business angels.
Incorporated
The process of forming a limited liability company. The process involves creating a separate legal identity for the business, and the creation of shares, or equity.
Venture Capitalist
Usually a professional investor, often another company, interested in high growth, high risk businesses, who will invest an amount into a business in return for shares, and an expectation for a high return. Venture capitalists are usually interested in larger investments of around £250,000 or more.
Business Angel
A wealthy, entrepreneurial individual willing to invest in a small, high risk business who expects a high return. The business is likely to have high growth potential.
