External Sources Of Finance

Question 1

External Sources Of Finance

Answer 1

The places where finance can be raised from outside the

business

Question 2

Owner’s Capital

Answer 2

This is money invested in the business from the owner’s personal savings

+ No interest payments or need to repay
+ It is a long term option

• Amount available is likely to be limited
• If the business is owned by shareholders they will expect higher dividends in the future

Question 3

Loans

Answer 3

Loans are money borrowed from a financial institution normally for a set period of time and for a specific purpose

+ Regular pre-agreed repayments make planning and
budgeting relatively easy
+ Ownership or control is not lost

• Interest rates charged on the amount borrowed can fluctuate
• Often secured against an asset which can be seized if
  repayments are missed

Question 4

Crowd Funding

Answer 4

This involves raising funds online by asking people to invest a small amount of money each

+ Offers the ability to raise finance from a large number of investors
+ No interest is paid

• Short term source of finance
• No guarantee that the crowd fund will attract
  sufficient investment to meet the target

Question 5

Mortgages

Answer 5

These are long-term loans, normally around 25 years, that are secured against a specific asset, for example a building

+ Business has immediate use of the property with the payments spread over time
+ Business will own the property after the last payment has been made

• Often secured against an asset which can be seized if
  repayments are missed
• Interest has to be paid regardless of whether a profit
  is being made; business needs to budget for the continuing maintenance of the property

Question 6

Venture Capital

Answer 6

Funds from a professional investor in return for a share of the ownership of the business

+ Investor can offer the business guidance and support
+ Long-term investment

• Partial loss of ownership and control
• Investor may expect quick returns on their investment

Question 7

Debt Factoring

Answer 7

This involves selling on the businesses invoices to a third party (e.g. debt collecting agency) in order to receive the cash quickly

The factor company pays the business a percentage of the money owed and takes on the responsibility to chase the debts which need to be repaid

+ Speeds up the flow of cash into the business from
debts
+ The factor company takes on the risk of bad debt

• Only receive a percentage of the amount owed,
  therefore reducing profits
• Short term one-off funding option

Question 8

Hire Purchase

Answer 8

This involves paying to use an asset in instalments to spread the cost over its useful life and hence provide a source of finance

The asset will remain the property of the seller until the final instalment has been paid

+ Avoids the need to pay a lump sum for the use of an
asset
+ Regular instalments make planning and budgeting
easier

• Overall amount paid for the use of an asset is likely to be higher than if purchased outright
• Increases the volume of cash outflows

Question 9

Leasing

Answer 9

This involves paying to use an asset in instalments to spread the cost over its useful life and hence providing a source of finance

Ownership of the asset stays with the supplier throughout the length of the lease agreement

+ Responsibility for maintaining and repairing the asset stays with the supplier
+ Spreads the cost of an asset over its life to avoid paying a lump sum up front

• Overall amount paid for the use of an asset is likely to be higher than if purchased outright
• Never actually own the asset and therefore payments are ongoing

Question 10

Trade Credit

Answer 10

This is a period of time offered by suppliers to allow the business to purchase a good or service now and pay at a later date, for example 30 days after purchase

+ Delays the need to pay for goods and services purchased, therefore aiding cash flow
+ Business has use of goods immediately

• Requires robust financial records to keep track of outstanding debts
• Only suitable as a short-term source of finance

Question 11

Grants

Answer 11

This is a lump sum provided to a business by the government to be used for a specific purpose with conditions e.g. creating jobs

+ No need to repay and no interest charges
+ No loss of ownership or control

• Certain criteria has to be met to qualify
• Might only be awarded if certain conditions are met

Question 12

Donations

Answer 12

These are sums of money given voluntarily to a charity or social enterprise

+ No need to repay and no interest charges
+ No loss of ownership or control

• Likely to be small amounts only
• Unpredictable

Question 13

Peer To Peer Lending

Answer 13

Small investors use an organisation to help them find businesses to invest in and that organisation takes a fee for matching the investor to the business

+ Long term funding option
+ Can be useful for businesses that cannot secure finance from traditional financial institutions

• Interest may be higher than those charged by financial institutions

Question 14

Invoice Discounting

Answer 14

The business borrows against the value of its outstanding invoices for a fee

This differs from debt factoring where the business “sells” it’s outstanding invoices to a third party

+ Short term option that allows the business to still manage the relationship with the customer

• Can lead to loss of some profit