Sources of finance. Flashcards
Why do businesses need finance?
To buy fixed assets like factories and machinery, as well as working capital to ensure the business can survive.
What are sources and methods of finance?
Sources of finance are providers of finance. However methods of finance are how providers of funds actually provide the funds. E.g. a bank would be a source of finance but a loan would be the method.
What is the difference between short and long term finance?
Short term finance is capital that a business will usually repay back within a year. Whereas long term finance often requires more time to pay back for longer projects such as building factories; they are usually payed back in 3 years or more.
What must businesses consider when choosing a source of finance?
Amount required, level of risk involved (also applies to the financer), cost of the finance (e.g. interest).
What are internal sources of finance?
Finance that comes from within the business. This could be selling assets, owners capital or retained profits.
What is owners capital? Who is likely to use this method of finance and what are the benefits and drawbacks?
Owners capital is money the owner(s) invest into the business, often from their personal savings.
- Sole traders or partnerships are more likely to use this method of funding - they are relatively small businesses who don’t require large sums of money - they also may not be able to access other forms of finance.
The advantages are, it is easy to access and doesn’t require payback. However, the amount that can be raised is limited and depends on the owner.
Selling assets - What, who, AD/DIS?
Businesses can sell some of their assets to generate capital.
This is appropriate for businesses with spare assets, so it is not useful for new, or efficient businesses who have very little waste.
It is a cheap source of finance as businesses don’t pay interest on the money they raise in this manner.
However, the business may need the asset in the future, could end up making a loss as many assets depreciate and can take a long time to sell and get the cash which may be needed quickly.
Retained profits.
Profit can be retained over a matter of time and re-invested into a business in the short and long term.
This will obviously only work for businesses with sufficient profits to reinvest - some businesses are set up with this model - unlikely for new businesses who are trying to break even.
- No interest.
However, shareholders may object to this as it minimises dividend payments. Also, retaining profits could mean the business may miss out on potential opportunities.
-For most businesses they will use some of their retained profits in conjunction with other sources, as it is not enough on its own to expand.
What are external sources of finance?
These are sources of finance that come from outside of the business.
Family and friends - What who, AD/DIS?
-Owners of small or new businesses may ask family or friends for funding.
- A benefit is family and friends are more likely to be generous with payment and will be more willing to agree to a flexible repayment with little to no interest.
However, the amount of money available may only be small, and borrowing from family and friends could potentially damage personal relationships.
Banks - What, who, AD/DIS?
Banks are a common source of finance and can offer a variety of methods of finance e.g. overdrafts, loans and mortgages.
They are for all different types of businesses, but may be selective with who they lend to.
Banks are credible financial institutions and their T+Cs are clear. They can also advise businesses to a degree.
However banks do not lend to everyone - only where they are certain they will be paid back with agreed interest rates - so riskier small businesses may not receive finance.
P2P lending.
P2P lending are online lending companies. They allow individuals to lend money to other people and businesses. Lenders provide info on what they will lend and what interest they will charge, whilst borrowers provide info on what they want, why and how long they will loan for. The lending company then assess the risk of lending and matches it with a lender (riskier = higher interest.)
They are usually cheaper than a bank loan with lower interest, and better for businesses unable to obtain a bank loan.
However, there is no/minimised government regulation or legitimacy with this method.
Venture capital
Venture capitalists are wealthy people who invest into businesses they think have good growth potential. They offer finance and usually advice to businesses they involve themselves in, in return for a share of the business.
The knowledge they can provide is a benefit, as well as often good connections.
However, this can be difficult to obtain and requires giving away a degree of control to someone else which impacts the owners authority over the business.
Crowd funding.
Crowd funding is a large amount of people raising funds, usually via the internet. Usually lots of people will individually contribute a small amount, but the collective will raise a lot - common for start ups.
To do this, a business will provide details of their plans on a public crowd funding website so people that like the idea can contribute - they are also sometimes incentivised with offers.
This can raise awareness about a business for free, and doesn’t require any payback.
However, by the business putting their idea in public domains, their idea could be stolen. Also the idea failing could be risky as many people will know and may impact the businesses reputation.
Other businesses
Businesses with large retained profits may want to invest rather then saving profits, especially when interest rates are low.
A business may want to aid another business that could enhance their success, could be a supplier to improve the supplier - business relationship.
However, the external business may want a share of profits, and could gain power over the business and it’s autonomy.
