Financial Institutions and sources of funding 4.1 -4.6 Flashcards
Organisations that deal with monetary transactions including investments,loans and deposits
Types of financial institutions
1.Banks
2.Finance companies
Functions of financial institutions .
Deposit:Money that is able to be deposited into savings and investment accounts.
Distributed :**Money distributed through loans and credit. **
Define Banks
Financial organisations that offer a variety of deposit ,investment and loan services to cuatomers
Key distinction Between banks and financial companies
Banks offer a variety of deposits The money collected from depositors and money earned from investments is used to fund loans to customers.
Finance companies on the other hand provide loans for businesses hey gain funding from banks and other financial institutions at a set interest rate and use these funds to extend credit to customers.
need to get a read of this
Define finance companies
Financial organisations that focus on providing loans to business customers
Sources of internal funding
- Retained profits
what are retained profits ?
Profits** saved by a company for future purpose and immediately reinvested in the business or issued to shareholders**
A business can use retained profits as an internal funding source. A cash reserve is built up by allocating profit to be ‘saved’ and kept by the company.
how reatined profits can be used by a buisness
* can then be used to finance operations,
* pay off business debt or asset purchases.
Benefits of retained profits
✅ Retained profits allow a business to avoid increasing debt and the dilution of ownership that results from issuing more shares.
✅ This option allows a company to maintain full control of the business rather than complicating management with creditors, new partners or outside investors. Involving financiers, investors or new owners in the company gives them a degree of influence in how the business is run.
Disadvantages of retained profits
❌ It may be a slow process to accumulate the required funds.
❌There may be a difference between profit on paper and cash flow due to sales and purchases being on credit.
❌The business also needs cash to fund ongoing operations. If a company ‘saves’ too much profit there may not be enough capital to finance operations. A company may then need to borrow funds anyway for working capital…
overall on retained profits
retained profits are one of the most significant internal sources of funding a business has access to. This requires the business to carefully save a portion of its profits overtime to build up a small reserve that can be used for a larger or more costly business expansion initiative. Having said this, the business must be profitable and stable in the medium to long-term in order to build up retained profits. Additionally, saving too much profit to attempt to build up a large reserve of retained profits may require the business to take out short term loans in order to finance business operations.
Define external Funding
Funding that business can access that are outside the organisation
7 sources of external funding you need to know.
1.debentures
2.share capital
3.trade credit
4.venture capital
5.secured loans
6.financial institutions
7.government
Where else can businesses access capital and extra funding?
Debentures
Long-term debt instruments issued to companies (Defination)
Key Characteristics & descriptions
* Unsecure bonds sold to buyers that are backed by the general credit of the issuer
* Pay fixed interest rate back to buyer to provdie them with benefit
* They dont dilute ownership and r not like shares
Key Points of Debtures
- A company issues a prospectus detailing their financial performance, future plans, the details of the debentures and how to apply for them.
- They can be sold to an open market.But unlike shares denture holders are not owners of the company and do not have voting rightd
- Debentures pay a fixed amount of interest at regular intervals over a fixed period of time.
What is the reason for choosing A debenture?
**To raise large amounts of capital long-tern without giving up equity.
And also debtures do not incur debt **
Share capital Definition and Key characteristics
Funds raised by issuing shares for a limited company to shareholders .
Characteristics
*it inolves selling ownership equity of a business to buyer who inturn becomes a company’s shareholder
Shareholders receive dividends and have voting rights.
Key Points in Share capital
- A new company raises money by selling shares in an initial public offering (IPO) or an existing company can issue shares to finance a new project or expansion.
- Holders of shares have the right to vote at general meetings of the company.
- Shareholders are entitled to a share of company profits through the payment of dividends.
Shares are a good source of finance, but the impact on the ownership of the company and makes company management more complex.
Why would a business use share capital ?
This source is chosen to raise significant capital in a short time and also improves creditworthiness as this does not incur debt
Trade Credit definition and key characteristics
Short-term credit extended by suppliers to businesses for goods and services that have been delivered but not yet paid for.
Key Characteristics ;
Suppliers allow businesses to purchase goods or services and pay for them at a later date, typically within 30-90 days.
Key points for Trade credit
Companies provide a period of time for invoices to be paid by customers.
This period of time is set by the company and can be anytime (e.g. 2 weeks, 30 days)
This gives a customer a form of interest free finance to delay payment.
They receive the goods or services but can pay for it at a later date.
Reasons for using trade credit
Businesses use trade credit to manage cash flow and reduce the need for immediate cash outflows.
Venture Capital
Investment funds provided by venture capitalists to startups and small businesses.
Venture Capitalist invest in high potential startups in exchange for a share of equity in the business,or for repayment of interest over a number of years
They often provide managerial and technical expertise to the business to enhance the likelihood of business success.
Key Points for Venture Capital
- A trading bank is likely to not approve a loan to a new business or a new project.
- Venture capitalist are more willing to take the risk because the agreement for finance includes their involvement in the management of the business or project.
- Instead of a loan, venture capitalist invest in the venture and are entitled to a return that is much higher than just charging interest on a loan.
- Venture capital is a source of finance for high risk projects, but the cost can be high and can often involve venture capitalist being involved in making decisions.
Why do business use venture capital?
Chosen for access to large amounts of capital and expertise to scale the business rapidly.
However, equity is sacrificed in exchange for funding.
Secured Loans
Finance obtained from bank or other financial institution in exchange for fixed or variable interest rates, which have been backed by assets from the borrower.
Businesses Provide assets as security to obtain loans.If borrower defaults on the loan payments,the lender can seize the Collateral iin exchange for outstanding money owed
Why would a business invest in secured loans ?
It Offers Lower interest rates reducing expenses due to reduced risk for the lender and larger loan amounts
Financial instutution(sources of finance)
Financial institutions offer loans, credit lines, and other financial products with specific terms and conditions.
Banks, credit unions, and other institutions providing various methods of access to both short and long-term sources of funding.
Government Funding
Funding provided by government bodies through grants and loans and subsidies
It is aimed at suporting specifi industries or projects
Why would business invest in financial institutions ?
Businesses choose these for structured financing options and the ability to **establish credit history. **
Businesses may already have an existing relationship with the financial institution which may secure them more favourable interest rates and other fees and terms.
Key Characteristics of Government funding
- Goverments grow economies by supporting business investments
- They do this by providing financial incentives to encourgae business expansion,expand innovation ,training and employment
- Often they do this for financial support
Why would business choose GOVERNMENTS For Funding?
Chosen for non-repayable grants, low-interest rates, and support for innovation and growth.
