Sources of finance Flashcards
why is finance not readily available for new businesses?
because they will rely on capital provided by the entrepreneur themself and friends and family so their sources of finance will be limited and they are likely going to continue to struggle to find external sources of finance until they establish an effective trading record
what things does the most suitable finance option depend on? give 6
how much funding is needed?
the amount of time the money is required for
what will the finance be used for
the affordability of repayments
whether or not personal or business assets are available as security
whether or not the business owner is willing to give up a share of ownership, perhaps through taking a partner or selling shares
what are four sources of internal finance?
owners capital
retained profit
working capital
sale of assets
define owner’s capital
the money that the entrepreneur may have saved/gained from other sources
what is an advantage and disadvantage of owner’s capital?
adv:
does not need to be repaid and no interest is incurred
disadv:
unlikely that it will be adequate to finance the entire business/start-up and carries a high level of risk as if the business fails the owner has lost all it’s capital
define retained profit
the profits kept after dividends have been paid to shareholders
what is an advantage and disadvantage of retained profit?
adv:
cheap and readily available and doesn’t incur any interest as long as profit is made
disadv:
there is an opportunity cost involved eg shareholders may prefer to be paid by retained profits
define working capital
money that is used to run the business day-to-day and this can be increased by reducing their trade credit period offered to customers and collecting debts quickly
what is an advantage and disadvantage of working capital?
adv:
it is a short-term source of finance and can help businesses manage their cash flow better
disadv:
can dent reputation if demand cannot be met if stock is not available
customers may go elsewhere if their trade credit is reduced
define sales of assets
when the business can sell premises, machinery and other assets
what is an advantage and disadvantage of sales of assets?
adv:
it will bring in a lump sum immediately and in the long run will reduce the cost of running that asset
disadv:
business has lost the use of the assets
smaller businesses unlikely to have unwanted assets
if growth is an objective, more likely to acquire more and keep assets
what are 11 external sources of finance?
borrowing from friends and family
bank loans
overdraft
trade credit
factoring
leasing
commercial mortgage
sale and leaseback
share capital
venture capitalists
government grants
define borrowing from friends and family
where the business owners borrow money from their family and friends and tends to be informal
what is an adv and disadv of borrowing from friends and family?
+
low rates/no interest
easy to negotiate/set up
immediately available
-
informal so people may fall out
if circumstances change, urgent repayments may be required
if business fails, owner has lost friends/family’s captal
define bank loans
borrowing a fixed amount for a fixed period of time
monthly payments are made up of interest and capital
what is an adv and disadv of bank loans?
+
can be difficult for small businesses to secure but once agreed all of the money is readily available immediately
fixed repayments spread across longer periods help businesses manage their cash flow
-
interest must be paid on top of the capital borrowed which increases fixed costs
banks require proof that a business can repay their debt
it’s difficult to get for those with no proven track record
define overdraft
the facility to withdraw more from an account than is in the bank account resulting in a negative balance
what is an adv and disadv of an overdraft?
+
flexible way of borrowing
useful for day-to-day transactions easing cash flow needs
only pay interest when account is overdrawn
-
expensive form of borrowing as interest is much higher than other loans
maybe an arrangement fee
can be called in withdrawn by a bank with 30 days of notice - repayable on demand
define trade credit
a business buys from its suppliers and pays at a later date so a short-term interest free loan
what is an adv and disadv of trade credit?
+
useful short-term finance to help manage cash flow better as the firm can sell their goods and generate profit before paying suppliers
usually interest free if the business pays suppliers within the agreed credit terms
-
if business owes too much suppliers may stop supplying
won’t benefit from cash discounts related to prompt payment
source of finance is limited to goods supplied and can’t be used for general business expenses or growth
define factoring
for larger firms it’s possible to let a debt factoring company buy problem debts
it’s where the business sells customer accounts that have outstanding bills to a third party business who will recover this debt
what is an adv and disadv of factoring?
+
business receives a lesser amount than the original debt but receives it quickly and can now spend this cash
factoring firm will take responsibility for recovering the money owed to the business, improving cash flow
-
will not receive the full amount which was originally owed
not suitable for start-up businesses as they won’t have big debts
define leasing
where a business pays for the use of an asset but will never own it, improving short-term cash flow compared to buying the asset outright
they will never own the asset
what is an adv and disadv of leasing?
+
likely to get a replacement machine if it breaks down
useful if machinery is only needed occasionally
a form of renting - no large sums of money required
-
more expensive over machine lifetime than buying it
will never own it
define commercial mortgage
business gets a long-term loan in order to purchase a property
what is an adv and disadv of commercial mortgage?
+
may run for 10-15 years and have predictable costs which helps budgeting and cash flow
-
failure to make repayments may lead to property getting repossessed
define sale and leaseback
business sells assets to a finance company and leases the asset back
what is an adv and disadv of sale and leaseback?
+
asset can be turned into capital for reinvestment in the business and growth
carries potential tax benefits as the leasing costs are offset as an operating expense
-
no longer owns the asset
may not receive market-rate for the asset
define share capital
selling a share of the company to investors who seek a return on their investment via increasing share price and dividends
what is an adv and disadv of share capital?
+
business doesn’t have to pay interest
can sell more shares as and when funds are needed in the business
-
can dilute the control of the business owners
can leave original owners vulnerable to takeover threats
define venture capitalists
selling shares to a business/individual that specialises in investing in SMEs that are expected to grow quickly
what is an adv and disadv of venture capitalists?
+
business doesn’t pay interest
can benefit from the expertise of the venture capitalist
-
vc will want a say in how the business is run and share the profits of the business
only invest in businesses expected to grow quickly
define government grants
gov. may offer finance to start-up businesses but the qualifying criteria tend to be narrow and businesses setting up in regions of high unemployment are more favoured
what is an adv and disadv of government grants?
+
money doesn’t need to be repaid
interest-free
- there are administration requirements - strict criteria
certain conditions must be met
amount available is relatively small and for a limited time
what are 6 factors that must be considered when deciding upon a source of finance?
existing borrowing
risk
short vs long-term source
interest rates
security against loans
availability of finance
evaluate the 6 factors that need to be considered when deciding a source of finance to a start-up business
existing borrowing -
not applicable
risk -
high risk as 80% that business will fail within 18 months
may have to use personal assets as security against loans
short vs long-term source -
short-term is better as less risky since the business may be unsuccessful or not have a high enough turnover rate to afford longer term borrowing with additional interest repayments
interest rates -
significant cost for the business
affects level of profit made
security against loans -
unlimited liability for sole-traders
they will have to use personal assets as security against borrowing
availability of finance -
usually rely on personal savings/money from family
smaller range of sources available
external borrowing harder as business hasn’t made any sales
evaluate the 6 factors that need to be considered when deciding a source of finance to an existing business
existing borrowing -
need to consider the amount of existing borrowing and interest to be paid
risk -
less risk as they are more established in the market
proven track record so can take advantage of supplier discounts and trade credit
short vs long-term source -
depends on how established business is
easier to get large sums of money that require longer payback periods due to higher sales value/volume
interest rates -
affects cost and profits made if interest rates rise
security against loans -
owners are a separate legal entity in limited companies, only the assets of the business will need to be used as security
availability of finance -
more sources available to established businesses
can take up better credit terms due to proven track record of sales/success
