Key sources of finance Flashcards
Debt Factoring
-Short-term
-External
-Business sells their outstanding sales invoices (receivables) to a third party (factoring company) at a discount
Benefits of debt factoring
-Receivables are turned into cash quickly (improves cash flow in the short run)
-Limits risk of waiting on customers that may or may not actually pay their invoices
-There is no security needed like a bank loan or overdraft
Drawbacks of debt factoring
-Quite a high cost, factoring company costs more than using a bank loan
-Loss of revenue (5-10%) as the factoring company pays the business around 90-95% of their receivables
-Customers may feel their relationship with the business has changed (forceful collection of receivables)
Overdrafts
-Short-term
-External
-Bank allows an individual or organisation to overspend its current account in the bank up to an agreed limit for a stated time period
Benefits of overdrafts
-Flexible: can be used on a short-term basis if a business has a temporary cash flow problem
-The business only pays interest when overdrawn
-You can withdraw more than what is in your account
Drawbacks of overdrafts
-Banks can cancel or limit the overdraft at any time
-Paperwork needed to show why the overdraft is needed which can be time-consuming and distract the manager from their usual activities
-Flexible interest rates so a business may find payments going up or down, making it hard to budget as payments aren’t fixed in advance
Retained profit
-Long-term
-Internal
-Profit that is reinvested in the business rather than distributed to shareholders
Benefits of retained profit
-Cheap as there is no interest payment
-No security needed as the organisation is using its own funds
-Independence and confidentiality, the organisation doesn’t need to provide any information to obtain this source of finance, and also maintain full control of the business
Drawbacks of retained profit
-Impacted dividends as shareholders are deprived of the money they are meant to be receiving (shareholder conflicts)
-Likely to be finite so other sources should be used alongside it
-No expertise from bank managers, financial advisers or shareholders
Share capital
-Long-term
-External
-Money given to an organisation by shareholders in return for part ownership and a share of the profits (dividends)
Benefits of share capital
-Shareholders can bring expertise to a business
-Permanent, the business does not have to repay its share capital
-A business does not have to pay dividends if they have poor profits/make a loss
Drawbacks of share capital
-Loss of control for the owners as shareholders gain partial ownership
-Conflicted objectives, shareholders may not have the same values as owners
-Possible high dividend payments when profits are high, expensive for the business and limits other uses for profits
Loans
-Long-term
-External
-A sum of money provided to a firm or individual by a bank for a specific, agreed purpose and providers of loan capital are known as creditors
Benefits of loans
-Easy to budget, interest rates and repayments are fixed in advance so it is easy to plan a schedule for repayments
-Designed to meet the organisation’s needs, size and period of repayment are aligned to needs
-Lower interest rates than overdrafts due to the security provided
Drawbacks of loans
-No flexibility, repayments are a fixed agreement
-May not be given to smaller businesses
-Time-consuming process (many documents needed)
