Methods of finance. Flashcards
What are some short term methods of finance?
Overdrafts, leasing, grants and trade credit.
What are overdrafts - AD/DIS?
Overdrafts are where banks allow businesses to trade with negative amounts of cash in their bank account.
They are easy to arrange and flexible - businesses can borrow as much as they need (to a certain point) and they only pay interest on the cash they use.
However, they charge high interest rates. There may also be a fixed charge for them so they do not work in the long term.
Leasing
Paying to use another businesses assets. - When a business cannot afford new assets, they can lease them. This involves paying monthly sums of money over a set period of time in return for the use of the asset. After the lease period, the asset is returned.
- An advantage of leasing is that a business doesn’t need to pay a large up front sum for an asset, which would be hard on cash flow. Also, the asset leased is often up to date and less likely to become faulty.
However, in the long run it may cost more than outright purchasing the asset.
Grants
A grant is a fixed sum of money given to a business, often by the government - usually to fund specific projects.
A business needs to apply for a grant and has to provide a lot of information regarding the specifics of the project e.g. jobs created, cost to environment etc.
It doesn’t have to be repaid at all; the application also forces the business to thoroughly plan for the future.
However, it can be long and time consuming without a guaranteed result. Also the firm only receives the cash after the completion of the project so has to initially fund it in other ways. The government also place strict criteria; if not met, the cash could be retracted.
Trade credit.
When a business buys a good or service and doesn’t have to pay straight away. The business pays within an agreed time period (usually 30-90 days).
This can help a businesses cash flow to help them finish their projects.
However, this could mean missing out on EOS benefits, and if the business cannot pay in time, the business will be charged interest on all the missing credit and could be charged a fee. They will also receive a bad credit score.
What are some long term methods of finance?
Loans, share capital, venture capital.
What are loans - AD/DIS
-Businesses can take out loans to finance long term projects.
Loans are where a fixed amount is borrowed and paid back over a fixed time period with interest.
-Banks, family, P2P can offer loans.
-In the event a loan is not paid back, prior to the lending, security may be needed to ensure the person providing the loan does not loose money and can take possessions as compensation for an unpaid loan.
-Loans are good long term finances for start ups who need capital for assets - not for working capital.
-A benefit of loans is the only payback required is the loan plus interest - no shares or dividends.
-However, loans can be hard to obtain as a lender will only lend when they think they will get all their money back + interest - if a business does not own any backup assets that can be used as security, they may not be able to obtain a loan.
Share capital
Method of finance for LTDs and PLCs.
- LTDs and PLCs can be financed in the long term by selling shares (% of the business ownership) in return for capital.
- No money needs to be repaid and can receive aid from investors.
- However, loss of control for original owner and dividends required.
- Selling shares is time and capital intensive, so is only used for raising large amounts in the long term.
Venture capital.
Can be used for businesses with high growth potential.
- Can finance high risk, high reward businesses (start ups and existing business seeking growth.)
- Can be provided by venture capitalists on behalf of venture capital firms - they are more likely to invest more (over £1 mil) into a business than business angels - individuals.
- However have to give up shares and often a large degree of control.
- No repayments and can provide advice.
