Sources of Finance

Question 1

What is retained profit?

Answer 1

Retained profit is an internal source of finance that comes from having a financial surplus. These funds are reinvested in the business, rathe than being distributed to the owners (shareholders).

Question 2

Advantages of retained profit

Answer 2

• Retained profit does not incur any interest charges
• It is considered as a permanent source of finance, because it doesn’t have to be repaid
• Flexible: the business can use this for any purpose within the business. (Bank loans are approved for specific uses only)

Question 3

Disadvantages of retained profit

Answer 3

• Start-up business don’t have any retained profit
• Retained profit is rarely enough as a sole source of finance for most businesses in their pursuit of growth and evolution
• Less dividends paid out to shareholders and owners of the business

Question 4

What is trade credit?

Answer 4

Trade credit enables a customer to purchase and obtain goods and services but to pay for these at a later date.

Question 5

Advantages of trade credit

Answer 5

Allows time for businesses to process raw materials into goods/services and earn revenue so they can pay for the raw materials

Question 6

Disadvantages of trade credit

Answer 6

• If payments on invoices are late, businesses can be charged overdue payment penalties.
• The typical trade credit period is between 30 to 60 days.

Question 7

What is leasing?

Answer 7

Leasing involves the business or customer drawing up a contract with the leasing company to use particular non-current assets for an agreed fee. Ex. machinery

Question 8

Advantages of leasing

Answer 8

• The lessor does not have to purchase the expensive equipment
• Leasing is particularly advantageous if the business only needs to use the fixed capital for a short period of time, or if it does not want to deal with the hassles and costs of repairs and maintenance.

Question 9

Disadvantages of leasing

Answer 9

• The lessee never owns the asset. Ownership remains with the lessor.
• Over a long period of time, leasing can be more expensive than buying the asset outright.

Question 10

What are business angels?

Answer 10

Business angels are wealthy and successful private individuals who risk their own money in a business venture that has high growth potential

Question 11

Advantages of business angels

Answer 11

• Supplies to businesses that are unable to secure finance from conventional providers of finance, such as commercial banks.
• The business can benefit from the expertise and experiences of the business angels, who are likely to provide their input in order to secure a significant return on their investment (ROI).
• Useful for small businesses and inexperienced entrepreneurs who are unable to raise sufficient finance on their own.

Question 12

Disadvantages of Business Angels

Answer 12

• For the business angels, such business ventures are extremely high risk. Hence, the amount of finance available is often not easily available for start-ups and small businesses.
• Such finance is difficult to come by, not only due to the risks involved but also due to the large number of entrepreneurs competing for such funds.
• The use of business angels will dilute the firm’s control and ownership as the angel investors will want a share and say in the organization.

Question 13

What is share capital?

Answer 13

finance raised through the issuing of shares via a stock exchange (or stock market). It is a long-term source of finance for limited liability companies, obtained by selling shares in the company.

Question 14

Advantages of share capital?

Answer 14

It is permanent capital as it does not need to be repaid (shareholders sell their shareholdings to other buyers via the stock exchange).

There are no interest payments made to shareholders, thus this reduces the expenses of the company.

Unlike loan capital, share capital does not involve debt or incur interest repayments.

Any publicly held company can raise further finance by selling additional shares (a process known as a share issue).

Question 15

Disadvantages of share capital

Answer 15

Shareholders need to (at some point) be paid dividends if the company earns a profit.

Although share capital can raise a lot of money for a company, the ownership and control of the organization may be diluted.

Only publicly held companies can trade their shares using the stock market.