Sources of finance Flashcards
What are internal sources of finance
Money that is generated
from within the business or from the
business owners own capital
What is retained profit?
This is money that is kept from previous years profits rather than given to the owners or shareholders. The business will keep it to use in the new trading year.
What is a strength of retained profit?
This is the cheapest source of finance because it is money that belongs to the business and no interest will be charged.
This will provide a liquidity
buffer and potential funds for
growth.
What is a weakness of retained profit
There are often limited amounts of capital available because there are other demands on profit such as paying dividends to shareholders or investing in other business activities (opportunity cost exists).
What is working capital?
This is the money used to pay all of a business’ short-term expenses (paid within a year). Working capital is used to buy stock, pay off short-term debt and cover day-to-day costs.
What is a strength of working capital?
A business can access more capital by reducing trade credit periods. This will lead to a business receiving money from customers more quickly. Therefore, a business will have less need to borrow money. In addition, a business could hold less stock. This will lead to lower running costs due to reduced costs of storage.
What is a weakness of working capital?
Customers may be lost because of a lack of trade credit, which attracts customers to purchase goods, or due to a lack of stock if there are sudden increases in demand as the business may be unable to meet delivery dates
What is sale of assets?
This is when an established or large business sells goods that it no longer requires, such as equipment, machinery or vehicles. The business can then reinvest this money in other ways, such as buying new assets or paying for advertising campaigns
What are the strengths of sale of assets?
Once the assets are sold, the money is instantly available to be used. This is suitable for large businesses as they are likely to have old assets that may need to be replaced or renewed
What is a weakness of sale of assets?
It can take a long time to access money because it can be difficult to sell assets. This may lead to missed business opportunities. In addition, small businesses are unlikely to have assets to sell because they may need all of their assets or wish to pursue growth.
What are external sources of finance?
Money that is raised from
sources outside of the business
What is a bank loan?
A loan is borrowing a
fixed amount, for a fixed
period of time, perhaps
3–5 years
what are the strengths of a bank loan?
- If application for the loan is successful, the money becomes
immediately available. - Payments made up of interest and capital are made monthly,
which can help with cash flow planning. - Funds are made available for medium- to long-term borrowing
of large sums of money, for example if a business needs to
acquire building land.
What are the weaknesses of a bank loan?
- Interest has to be paid on the loan; thus, businesses have
to pay back more than what they borrowed. - Very difficult to obtain for small businesses. It is likely that
most new start-ups are unlikely to receive a loan unless
security is offered. - Some form of collateral may be required to secure the loan
– if the business owner is not able to maintain payments,
homes can be lost or business assets removed.
What is an overdraft?
An overdraft is the facility
to withdraw more from
an account than is in the
bank account, resulting in
a negative balance
What are the strengths of a overdraft?
- Very useful for overcoming short term liquidity problems –
useful for day-to-day transactions, easing cash flow needs and
emergency requirements. - Only pay interest when account is overdrawn, i.e. do not have
to pay off regular sums
What are the weaknesses of an overdraft?
- Interest charged can be very high indeed.
- The overdraft limit tends to be fairly low for small
businesses.
*Can be called in immediately – it is repayable on demand
What is trade credit?
Businesses buy items
such as fuel and raw
material and pay for them
at a later date.
What are the strengths of trade credit?
- The 30-90 days offered by suppliers can be viewed as interest
free way of raising finance.
What are the weaknesses of trade credit?
- Suppliers often offer discounts for cash or early payments,
meaning the cost of goods is higher if full credit period is
used. - Late payment can also lead to a business gaining a bad
reputation with suppliers.
What is factoring?
Factoring is a
method of turning
invoices into cash.
What are the strengths of factoring?
- Banks and other financial organisations offer factoring services
that pay a proportion of the value of an invoice (80–85%) when the
invoice is issued. The balance, minus a fee, is paid to the business
when the invoice is paid. - This flexible form of finance keeps pace with business growth as
the funding is directly linked to the turnover of the company. - The factor will also undertake all credit management and
collections work. - The use of this service results in savings in administration costs,
which can be substantial and faster customer payments means
lower interest costs on any overdraft facility.
What are the weaknesses to factoring?
- Factoring services are only offered to businesses with
a good trading record and reliable customers.
What is leasing?
The company gains
use of a productive
asset, without ever
owning it.
