Module 7: Sources of finance Flashcards
Cash flow assists with providing the following answers
How much cash is required
When it is required
How long it is required for
What is the most appropriate type/source?
Principles of raising finance. What ate the two principles the financial manager must consider when raising finance?
Matching (length of funding)
- match the life of the funding with the life of the asset (so you aren’t paying for an asset you no longer possess or income from the asset doesn’t cover repayments if funding is shorter than UEL)
Relationship between risk and return (type of finance)
- the higher the risk that an investor takes, the higher the return they will expect to receive on that money
Number of priorities should be considered when deciding appropriate sources of finance
- Liquidity - ST borrowings are reliable source of finance to meet working capital needs but there must be some assurance that the funds will be available when required
- Flexibility - ability to tailor the funding to the exact business needs. Price to be paid for this flexibility => higher cost of borrowing
- Diversification of source - have a variety of sources of funding, not reliant on one lender, competition between lenders may reduce the cost of borrowing. Business should not rely on one source of finance.
- Cost - reflect a combination of liquidity, flexibility and diversification. Cheaper funding obtained if profitable, well managed business that enjoys a good relationship with fund providers
Business plan headings
Executive summary
Market analysis and product description
Track record of the company
Details of mgmt team
Funding requirements and security offered
Financial projections (sensitivity analysis)
Business plan details the structure of the business - both operational and fianancial
Preparer of business plan should consider the concerns of the lender. What are these concerns?
- A market rather than a product focus - if no focus on market and just producing wide variety of products with niche market => unattractive
- Some track record that customers exist and they are happy => there is a current market
- Recognition of lender’s needs - how lenders/investors get their required return (debt security and interest rate reflecting risk and info on future profitability and dividend policy. Even future listing for exit route)
- Management control - credible description on how the performance is going to be monitored and controlled - so investment is safe
- credible projections - have two business plans: a conservative one for lenders and a ambitious one for management targets
Factors to consider when deciding what finance option is appropriate
Type of business/industry
Stage of development
Size of operations
Intended use (long, medium, ST)
4 categories of long-term finance
- equity - owners, control through voting rights, last to be paid, higher risk => higher return, most expensive)
- Debt - no voting rights, security, interest paid regardless, interest= tax deductible, paid before SHs, cheaper source of finance due to lower risk
- preferential shares - normally no voting rights, preferential rights over OS, fixed annual dividend
- Quasi-equity - features of both debt and equity, convertible bonds, bonds with equity warrants
When answering finance questions, think…
- Providers of finance
- Cost
- Investors’ rights
- Impact on gearing
Issues facing new small businesses
- Lack of financial mgmt expertise
- Under-capitalisation
- Ignorant of sources of finance
- Incorrect mixture of debt maturities
- Ignorant of need for cash planning and financial control
- Overtrading
- The ‘funding gap’
- Lack of security
Types of equity finance in small businesses
- Personal funds
- Venture capital
- Corporate venturing
- Business angels
- Investment crowdfunding
- Internally generated funds/retained profits and reserves
Business life cycle
Stage 1- Introduction Stage 2 - Take off Stage 3 - Slow down Stage 4 - Maturity Stage 5 - Decline
Types of debt finance available to new start up busineses
- Bank borrowing - bank loan or overdraft
- Enterprise Finance Guarantee (EFG)
- Gov’t grants
- Soft loans
- Hire purchasing agreements/leasing
- Factoring
- Local enterprise companies
FinTech
Financial technology to streamline and simplify access to financial services e.g. payments taken from customers by using their mobile phone and a bluetooth card reader
Automated investment services (robo advisers) make use of machine learning algorithms and enormous amounts of data to make lending easy and inexpensive (cutting costly human advisor element)
Two types of crowdfunding
Equity based Reward based (if owner does not want to dilute their share)
Other types of finance
Peer to peer lending
Islamic finance
Islamic finance instruments
