Learning Outcome D: Select and evaluate different sources of business finance Flashcards
Source of finance
Where money comes from
What determines which source of finance is most suitable?
What the money is for
True/False: Sources of finance are only long-term
False, they can be short-term or long-term
What is meant by a short-term loan?
A loan that needs to be paid back in one year
What is meant by a long-term loan?
A loan that needs to be paid back in a period of time greater than one year
Internal sources of finance
Money available to fund expenditure from within the business
Give 3 examples of internal sources of finance
Retained profit, net current assets and sale of assets
Retained profit
Profit (sales revenue minus total costs) kept in the business to fund future expenditure
Net current assets
Current assets minus current liabilities shows the money available in the business to fund day-to-day expenditure
Sale of assets
Selling an item of worth owned by a business in order to achieve an immediate cash injection
Give 2 advantages of retained profits as an internal source of finance
Any 2 from no interest charges, available immediately, only available up to the amount already accumulated by the business and therefore avoids debt and no loss of ownership (control
Give 2 disadvantages of retained profits as an internal source of finance
Any 2 from amount available may be limited, reduces payments to shareholders which may cause dissatisfaction and once used it is not available for alternative purposes
Give an advantage of net current assets as an internal source of finance
Encourages the business to manage cash flow effectively
Give a disadvantage of net current assets as an internal source of finance
Any from can put pressure on customers as shorter credit terms are offered and this negatively affects relationships with suppliers if longer credit terms are negotiated and lower stock holdings can affect the firm’s ability to meet customer needs
Give 2 advantages of sale of assets as an internal source of finance
Any 2 from no interest charges, reduces capital tied up in assets, releasing it for other purposes and can mean disposing of an asset no longer of use to the business
Give a disadvantage of sale of assets as an internal source of finance
Any from it is likely that the amount received is not a true reflection of the value of the asset and can increase costs in the long run if an asset needs to be leased back
External sources of finance
Those available from outside the business
Outline owner’s capital as an external source of finance
This is money invested in the business from the owner’s personal savings
Outline loans as an external source of finance
Loans are money borrowed from a financial institution normally for a set period of time and for a specific purpose. Interest will be payable on the loan
Outline crowd-funding as an external source of finance
This involves attracting investment from a large number of speculative investors many of whom may invest relatively small amounts. If cumulatively this matches the required amount then the investments are collected together. Normally makes use of the internet to attract investors
Outline mortgages as an external source of finance
These are long-term loans, normally around 25 years, that are secured against a specific asset, for example a building. Interest will be payable on the mortgage
Outline venture capital as an external source of finance
This is investment from an experienced entrepreneur in return for a stake (equity) in the business
Outline debt factoring as an external source of finance
This involves the selling on of a business’s debts to a third party 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
Outline hire purchase as an external source of finance
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
Outline leasing as an external source of finance
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.
Outline trade credit as an external source of finance
This is a period of time offered by suppliers to allow the customer to purchase a good or service now and pay at a later date, for example 30 days after purchase
Outline grants as an external source of finance
This is a lump sum provided to a business by the government or another organisation to be used for a specific purpose. For example, it could be used to provide employment in a deprived area or invest in the research and development of an environmentally friendly alternative to fossil fuels
Outline donations as an external source of finance
These are sums of money given voluntarily to charity or social enterprise
Peer-to-peer lending
This involves one business person lending money to another business person in return for interest payments
Invoice discounting
These are reductions offered to customers making a product or service cheaper, often applied as a percentage
Give an advantage of owner’s capital as an external source of finance
Any from no interest payments or need to repay and high level of commitment from the owner
Give a disadvantage of owner’s capital as an external source of finance
Any from amount available is likely to be limited and if there is more than one owner this could cause friction if everyone is not able to contribute the same amount
Give an advantage of loans as an external source of finance
Any from regular pre-agreed repayments make planning and budgeting relatively easy and ownership or control is not lost
Give 3 disadvantages of loans as an external source of finance
Any 3 from interest is charged on the amount borrowed, interest rates can fluctuate, often secured against an asset which can be seized if repayments are missed and interest has to be paid regardless of whether a profit is being made
Give an advantage of crowd-funding as an external source of finance
Any from offers the ability to raise finance from a large number of investors and no interest is paid as investors will only be rewarded if the business is successfully sold on at a later date
Give a disadvantage of crowd-funding as an external source of finance
Any from partial loss of ownership and no guarantee that the crowd fund will attract sufficient investment to meet the proposal
Give an advantage of mortgages as an external source of finance
Any from large amounts of finance can be raised and repaid over a prolonged period of time and ownership or control is not lost
Give 3 disadvantages of mortgages as an external source of finance
Any 3 from interest is charged on the amount borrowed, interest rates can fluctuate, 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 and not suitable for small amounts or as a short-term source of finance
Give an advantage of venture capital as an external source of finance
Any from finance is provided by a business professional who will often offer advice and mentoring alongside the investment and venture capitalists are often risk takers and may see the potential in a high risk investment that other investors including banks may not be willing to invest in
Give a disadvantage of venture capital as an external source of finance
Any from partial loss of ownership and control and conflict can arise between the entrepreneur and venture capitalist regarding the direction and day-to-day running of the business
Give an advantage of debt factoring as an external source of finance
Any from speeds up the flow of cash into the business from debts and the factor company takes on the risk of bad debt
Give a disadvantage of debt factoring as an external source of finance
Any from only receive a percentage of the amount owed, therefore reducing profits and can give the wrong impression or alienate customers
Give 2 advantages of hire purchase as an external source of finance
Any 2 from avoids the need to pay a lump sum for the use of an asset, regular instalments make planning and budgeting easier and spreads the cost of an asset over its useful life
Give a disadvantage of hire purchase as an external source of finance
Any from overall amount paid for the use of an asset is likely to be higher than if purchased outright and only really suitable for relatively low cost assets, e.g. vehicles and not premises
Give an advantage of leasing as an external source of finance
Any from responsibility for maintaining and repairing the asset stays with the supplier and spreads the cost of an asset over its life to avoid paying a lump sum up from
Give a disadvantage of leasing as an external source of finance
Any from overall amount paid for the use of an asset is likely to be higher than if purchased outright and never actually own the asset and therefore payments are ongoing
Give an advantage of trade credit as an external source of finance
Any from delays the need to pay for goods and services purchased, therefore aiding cash flow and no loss of ownership or control
Give a disadvantage of trade credit as an external source of finance
Any from potential loss of discounts offered for cash payments and only suitable as a short-term source of finance
Give an advantage of grants as an external source of finance
Any from no need to repay and no interest charges and no loss of ownership or control
Give a disadvantage of grants as an external source of finance
Any from often require a lengthy application process and might only be awarded if certain conditions are met affecting the way the business operates on a day-to-day basis
Give an advantage of donations as an external source of finance
Any from no need to repay and no interest charges and no loss of ownership or control
Give a disadvantage of donations as an external source of finance
Any from likely to be small amounts only and unpredictable
Give an advantage of peer to peer lending as an external source of finance
Any from interest rates can be lower than lending from more traditional financial institutions and fixed rate of interest can be agreed making it easier to plan and budget
Give a disadvantage of peer to peer lending as an external source of finance
Amounts available may be limited and provided for a short period of time only
Give 2 advantages of invoice discounting as an external source of finance
Any from no need to repay and no interest charges, no loss of ownership or control and reduces costs to the business so increases profit
Give a disadvantage of invoice discounting as an external source of finance
Often only available if purchases are paid in cash which affects cash flow
Retained profit is an internal/external source of finance
internal
Net current assets is an internal/external source of finance
internal
Sale of assets is an internal/external source of finance
internal
Owner’s capital is an internal/external source of finance
external
Loans are an internal/external source of finance
external
Crowd-funding is an internal/external source of finance
external
Mortgages are an internal/external source of finance
external
Venture capital is an internal/external source of finance
external
Debt factoring is an internal/external source of finance
external
Hire purchase is an internal/external source of finance
external
Leasing is an internal/external source of finance
external
Trade credit is an internal/external source of finance
external
Grants are an internal/external source of finance
external
Donations are an internal/external source of finance
external
Peer-to-peer lending is an internal/external source of finance
external
Invoice discounting is an internal/external source of finance
external
