Sources Of Finance Flashcards
Personal savings
When n entrepreneur uses personal finances such as cash in bank acc or less liquid assets such as stocks and shares to finance the business
What type of finance is personal savings and what type of business is it useful for?
Internal finance
Long term finance
Starting up/new businesses
Pros of personal savings
-no financial cost
+loan>pay interest
+shares>lose control
- easiest + quickest type of finance
Cons of ps
- likely to be limited with funds to cover all of the costs-not big enough funds
- if business does not initially make profit using savings=financial pressures
- loss of well being potentially
Retained profit
When a business uses historical profits from previous years to invest
Pros rp
-no financial costs \+no interest like with debt finance -no control given up/share given up ;no external influence \+control remains internal -safe low risk approach to expanding/investing So may make sense in recessions
Cons retained profit
-Conflict with shareholders-taking dividends-slice of profits for shareholders-mostly short term shareholders
-usually finite retained profits-slow growth-use alongside other sources of finance
-no expertise added, eg business angels aiding
+debt:banks
+equity:shareholders
Selling assets
Raising cash via the sale of surplus fixed assets
Eg spare machines
Spare vehicles
What type of finance is selling fixed assets and who would it be useful to?
- internal
- long term finance
- usually established businesses
Pros of selling fixed assets
- not a form of debt, no interest paid
- not a form of equity, no control given up
- providing you can find a buyer this is a quick source of finance
Cons of selling fixed assets
-only a finite amount of times you can do it as likely you have surplus assets
-some risk involved with selling assets , eg no willing or able buyer
+don’t receive fair value due to rushed selling
+fixed asset most likely decreased in price since originally purchase, price depreciation
Bank loans
When a business borrows a sum of money and pays it back with interest over an agreed period of time
Retained profit- who for and why useful?
- external finance
- long term
- start up/new business but can be used for any, just more useful for new businesses as they have less access to retained profit etc
Pros of bank loans
- common tool for expansion
- no share in business need to be given up (no equity)-form of long term debt-keeping control of the business
- lower interest rates than overdrafts therefore decreasing the overall costs
- able to be bespoke to business needs- I.e decided your repayment terms
- if you make frequent repayments-could improve credit scores-therefore increasing the amount of sources of finance you can use
- net assets increase therefore increasing business net worths
Cons of bank loans
- assets will be taken from you if you fail to repay-so it would be better to have limited liabilities
- no flexibility-must stick to repayment terms
- fail to pay can worsen your credit score therefore decreasing the number of sources of finance that you can use
- increases gearing of your business-long term debt
Crowd funding
Raising finance from large amounts of people who each contribute a small amount for a share of the venture/profit
What type of finance is CF and who would it be useful for?
- External finance
- long term finance
- new businesses
Pros of CF
-no repayments need to be made-no interest need to be paid
+form of equity finance
-great exposure
+large amount of investors
+common to get social media attention-oculus vr
-Good feedback-from investors-help improvements-they are aligned with the business
Cons of CF
- shared profits-less personal profit
- if venture/project fail risk of ruining the founder/business owners rep
- investors may have very limited expertise
Description of businesses that suit CF
- social media exposure
- easy to understand product
- niche market
New shares issue
When a limited company issues shares in exchange for a repayment
- shareholders
- equity finance-limited companies
Pros of new share issues
-no interest to be paid, no debt/loans-linked to equity
No repayments
-if plc - float on stock exchange- massive opportunities for finance-for business growth/expansion
+opportunity to raise huge amount of finance-incentivising employees if used as a profit share
-good exit strategy or cash in method
Cons of using new share issues
- give up share of business-give up 51%=lose of control-hostile takeovers etc
- expected you pay dividends therefore decrease in amount of retained profits
- if plc then you must undergo flotation can cost lots of money needed to be spent
Define venture capital
A type of finance where a VC will provide funding for a high risk’ high reward business in exchange for a stake in the business.
What type of financing is VC?
- external finance
- long term finance
- start-up businesses
What’s are the pros of VC
- this is an expansion type of finance, because they are more likely to fund larger amounts that the bank isn’t willing to finance
- there are no repayments needed, as it is a type of equity finance
- vc has expertise in the market
- reduces personal risk for owner cos vc is taking a % of that risk
Cons of vc
- given up share of the business- all profits made must be shared
- may lose control if 50% + of share is given up
- vc will leave after a good amount of profit is made
Overdrafts
When the bank allows you to withdraw more money than the back account contains
What type of finance is this, and who is it useful for?
This is an external finance, which is short term
Most efficient for new businesses/start ups
What are reasons a business might want a overdraft ? (2 reasons)
This would be an effective way to pay off unexpected expenditures
-this would ease the financial concerns of the business for a short while
What are the advantages of using overdrafts (2)?
-not a form of equity, all control is maintained by the owner of the business
-its a quick and efficient source of finance - easy to set up
-
What are the disadvantages of overdrafts?
- they require more interest payments than those on bank loans, due to there being no fixed payback date
- they can be cancelled at any time, but this is usually due to severe financial issues occurring within the business
- this can reduce the chance of getting a bank loan
Trade credit
When you buy raw materials or supply from suppliers immediately buy pay them back later.
What type of finance is this?
External finance, short term finance
What are the advantages to trade credit
Simple and easy to arrange and maintain if credit terms are met
- cheap form of short term finance, cheaper than back overdrafts
- no control of the business is given up
Cons of trade credit?
- if payment is late, delayed this can ruin the relationship with the supplier, also leading to bad credit score
- large fine owed if payments are made late
Advantages of an overdraft over a loan
-business only pays interest when overdrawn
-bank has flexibility to review and adjust the level of overdraft facility, perhaps on a short term basis
-overdraft can effectively be used a a medium-term loan
Being part of short term debt, the overdraft balance is not normally included in the calculations of the financial gearing.
Advantages of a loan over an overdraft
- business and bank know precisely what the repayments of the loan will be and how much interest is payable and when. Making cash flow more predictable
- the loan is committed —the business does not have to worry about the loan being withdrawn whilst it complies with the terms of loans
Why are personal sources important ?
- cheap in comparison with eg bank loans
- entrepreneur keeps equity over the business
- the more the founder puts in, the more others will invest
- little delay
Personal sources - redundancy (start ups)
- redundancy packages provide kick-start finance for a new business
- previous employers may also support other services (e.g) assets, training )
List the sources of finance
- family and friends
- banks
- P2P lending
- crowd funding
- business angels
- other businesses
What are the advantages of using family and fiends as a source of income?
- may be relatively cheap
- they may not want a stake in the business
- wont interfere with the running of the business
What are the disadvantages of using family and friends?
- serious problems could arise if the loan is failed to be repaid
- or if the terms of agreement where unclear
- leading to loss of relations
What type of finance do banks provide?
- loans
- overdrafts
- mortgages
Why are banks involved in a business start-up?
Business need a bank acc to facilitate financial transactions with customers and suppliers
P2PL
-involves people lending to unrelated individuals ,therefore avoiding the use of a bank.
How are p2pl transactions undertaken
They are mostly done online and are organised by specialist
Lists the specialists for P2PL
- Zopa
- funding circle
- lending works
- rate setter
What are the key features of P2PL
- all loans = unsecured - no lender protection
- the whole financial arrangement is conducted for profit
- all transactions online
- no previous knowledge / relations needed
- lenders can choose which borrower
- P2PL sites charge - at least 1%
Advantages of P2PL
- interest rates are better for both borrowers and lenders than those offered by the bank
- all transactions online = quick and easy process
Disadvantages for lenders of P2PL
-access to cash may not be instant -each operator has diff rules- money may be locked away for months or longer
Business angels
Individuals who typical invest £10,000 - £100,000 +
Often in exchange for a stake in the business
When do most business angels being investing
When a business is first starting up
Reasons people become business angels
- the excitement that comes from new ventures
- for tax relief from the government
How do crowd funding and p2pl differ
- P2PL are often individuals
- CF = groups
What is a loan
An arrangement where the amount borrowed must be repaid back over a clearly stated period of time, in regular instalments
Why are bank loans more expensive?
Due to the fact that it is deemed to be an insecure loan , if the borrower fails the repayment , the lender has no protection
Mortgages
Secured loans where the borrower has to provide some collateral to support the loan
What is meant by a secured loan
If the borrower defaults , the lender is entitled to sell the assets and use the proceeds to repay the outstanding amount
Debentures
- a specialised method of loan finance .
The holder is a creditor of a company , not an owner
.
-entitled to a fixed rate of return, but lack voting rights
-must be repaid on a set date
What type of company uses debentures
Public limited use this as a long term source
What is authorised shares?
The maximum amount shareholders want to raise
Deferred shares
- usually held by founders of the company
- only receive a dividend after the ordinary shareholders have received minimum
Ordinary shares
-all shareholders have voting rights
Preference shares
- receive a fixed rate of return once dividend is declared
- Entitled their dividends before ordinary shareholders
- can be redeemable - aka taken back
Leasing
A contract which a business acquires to use resources such as property, machinery or equipment, in return for regular payments
- ownership of items never passed
- often three years +
- then business has the option of purchasing resource
Advantages of leasing
- no large sums of money needed for purchasing of equipment
- maintenance and repairs costs are suppliers responsibility
- hire companies up to date equipment
- useful when equipment is required occasionally
- generally easier for a new company to obtain
Limitations of leasing
- over time is more expensive than jut purchasing the good
- loans cannot be secured on items which have been leased
Grants
- goverment funding
- basically free money
- no repayment
How long can debentures be financed for?
Up to 30 years
State two implications of limitations liability for a business?
Shareholders have protection from legal claims on the business , this is because the owner and business have separate legal entities
If the company collapses, owner is fully protected
