Sources of Finance Flashcards
Why Businesses need Finance
Finance refers to sources of money for a business. Firms need finance to:
- start up a business, eg pay for premises, new equipment and
advertising
- run the business, eg having enough cash to pay staff wages and
suppliers on time
- expand the business, eg having funds to pay for a new branch in a
different city or country
New businesses find it difficult to raise finance because they usually have few customers and many competitors.
Lenders are put off by the risk that the start-up may fail. If the business does fail, the owners may be unable to repay borrowed money.
Influences on Finance Decisions
There are many factors that will influence the types of finance a business decides to use:
- the purpose of the finance
- objectives of the organisation
- amount of finance required
- the type of business (not all sources of finance are available to all
businesses)
- length of time the finance is required for finance cost (interest
rates)
- payback terms
The main sources of finance
- bank overdraft
- bank loan
- grant
- commercial mortgage
- share issue
- debt factoring
- sale of assets
- crowdfunding
- debentures
- retained profit
- venture capital
Internal Finance
Internal sources of finance are funds found inside the business.
For example:
- profits can be kept back to finance expansion
- the business can sell assets (items it owns) that are no longer really
needed to free up cash
Retained profit
(internal finance)
Retained profit is profit that has been made by the business in previous years that is then reinvested back into the company.
ADVANTAGE - Does not need to be repaid
DISADVANTAGE - For profits to build up to use in this way can take too long and good business opportunities missed
Sale of Assets
(internal finance)
This is when a business sells items that they no longer need for example machinery or transport. They can then use this money to re-invest into other areas of the business.
ADVANTAGE - Does not need to be repaid
DISADVANTAGE - May be difficult or may take time to sell the assets
Bank Overdraft
(external finance - banks)
A facility that will allow you to withdraw more money from your account than is available. A bank overdraft is a short term source of finance.
ADVANTAGE - Can be arranged quickly
DISADVANTAGES - Expensive as a high rate of daily interest is
charged
- Usually only available for small sums of money
Bank Loan
(external finance - banks)
A long term source of finance. It is a fixed amount of money that is given to a business by the bank that has to be repaid over time with
interest, usually in monthly instalments.
ADVANTAGES - Can be arranged quickly
- Loan can be repaid over a long period of time
DISADVANTAGE - Interest has to be paid in addition to the loan
amount
Commercial Mortgage
(external finance - banks)
A long term source of finance. It is a sum of money borrowed from the bank that is secured against a business property and paid back in instalments, usually over a long period of time.
ADVANTAGES - Mortgage is given for a long period of time
- Large amounts of finance can be raised quickly
DISADVANTAGES - Interest is charged on the loan
- Property can be lost to the mortgage lender if
repayments are missed
Debt Factoring
(external finance - banks)
Debt factoring is a short term source of finance where firms sell their invoices to a factor such as a bank. They do this for some cash right away, rather than waiting 28 days to be paid the full amount.
ADVANTAGE - Time and effort is saved as the company is no longer
required to recover unpaid debts
DISADVANTAGE - Money is lost from the business as unpaid debts
are sold at a reduced value.
Grant
(external finance – other sources)
A grant is a fixed amount of money usually awarded by the government, EU (European Union) or charitable organisations. Grants are given to a business on the condition that they meet certain criteria such as providing jobs in areas of high unemployment.
ADVANTAGE - Does not need to be paid back
DISADVANTAGES - Business needs to meet certain criteria
- It is time-consuming to apply for grants and to
complete the paperwork
Share Issue
(external finance – other sources)
A source of finance that is only available to private or public limited companies. Such businesses can decide to issue more shares in the company and obtain finance from their sale.
ADVANTAGE - Finance raised does not need to be paid back
- Large amounts of finance can be raised
DISADVANTAGE - Shareholders need to be paid a dividend each year
- Shareholders become part owners of the business
Debentures
(external finance – other sources)
Loans given to the business by individuals. Interest is paid annually and the loan is paid back in full at an agreed date in the future.
Unlike shareholders, debenture holders are guaranteed their interest payment each year but do not hold a share of the company.
ADVANTAGE - Control of the business is not lost
DISADVANTAGE - Interest must be paid even if the company makes a
loss
Crowdfunding
(external finance – other sources)
Involves getting small amounts of finance from a large amount of people. This is usually done through social media or crowdfunding websites. Crowdfunding investors may:
- donate money
- get rewards for their investments
- receive a share of the profits
ADVANTAGES - Access to large amount of investors
- Fast way to raise finance
DISADVANTAGES - A public request for investment risks your project
being copied by competitors
- If the targeted amount isn’t reached the money is
returned to investors and the business gets
nothing
Venture Capital
(external finance – other sources)
Money that investors provide to a company that is starting up or expanding. Venture capital is usually used when there is an element of risk with the business.
ADVANTAGE - Available for more risky investment
DISADVANTAGES - Venture capitalists may want a share of the
business, meaning some control may be lost
- A larger return may be required due to the high
risk nature of the investment
