Sources of Finance Flashcards
What are the main reasons a business needs finance?
Start a business
Finance expansions to production capacity
To develop and market new products
To enter new markets
To pay for the day to day running of a business
Advantages of internal sources of finance (raised from within the business)
No interest has to be paid meaning it is a cheaper source.
The affairs of the business are kept private.
Does not have to be repaid.
Disadvantage of internal sources of finance
There may not be enough money available within the business.
Five internal sources of finance
Owner’s investment
Retained profits
Sale of inventory
Sale of non current assets
Debt collection
What is owner’s investment?
Money which comes from the owner’s own private financial resources.
This is a long term source of finance and is used when the amount required is not large.
Adv - doesn’t have to be repaid and no interest is payable.
Disadv - there is a limit to the amount an owner can invest.
What is retained profits?
Is only available for a business which has been trading for more than one year. It’s when profits are ploughed back into the business instead of the owner taking them out for own use.
This is medium or long term and is used when the amount is not large.
Adv - doesn’t have to be repaid and no interest is payable.
Disadv - not available to a new business.
What is sale of inventory?
Every business will have unsold inventory so they can raise finance quickly from selling off this unsold inventory at a discount.
This is short term.
Adv - quick way of raising finance and by selling off inventory it reduces the costs associated with holding it.
Disadv - business will have to take a reduced price for the inventory reducing profit.
What is sale of non current assets?
Businesses have large sums of money invested in their non current assets such as premises and equipment and sometimes will need to sell them.
This is a medium term.
Adv - good way to raise finance from an asset that is no longer needed.
Disadv - new businesses do not always have surplus non current assets they can sell off and there can be a limit to the number of non current assets a firm can sell off before it affects production.
What is debt collection?
Trade receivables arise when someone has bought goods and not paid for them. They owe the business money and usually pay after 30 days credit. Not all businesses have trade receivables I.e. those who deal only in cash.
This is a short term source.
Adv - no additional cost in getting this finance, it is part of the businesses normal operations.
Disadv - there is a risk that debts owed can go bad and not be repaid and the money which is owing by trade receivables is not working for the business.
Advantages of external sources of finance
Larger sums of money are available
The money is usually available more quickly
The borrower has the use of the asset while paying for it
Disadvantages of external sources of finance
It is more expensive as interest has to be paid
The lender requires security in case of non-payment
Different times for when finance is needed
Short term - up to 1 year.
Medium term - 1-5 years.
Long term - over 5 years.
What is a bank loan?
Where a bank agrees to lend a set sum of money to the business at an agreed rate of interest over a set period of time.
This is a medium or long term source.
Adv - set repayments are spread over a period of time which is good for budgeting.
Disadv - can be expensive due to interest payments.
What is a bank overdraft?
An arrangement with the bank whereby the business is allowed to be overdrawn on its account I.e. business is allowed to pay out amounts from its bank account to an agreed limit beyond the amount which has been lodged in the account.
This is a short term source.
Adv - good way to cover the period between money going out of and coming into a business bank account and cheaper than bank loan.
Disadv - interest is repayable on amount overdrawn.
What is additional partners?
Adv - doesn’t have to be repaid and no interest is payable
Disadv - diluting control of partnership If a partnership needs extra finance the existing can agree to invite an additional partner to join the business and the new partner will contribute capital to join.
This is long term source
What is a share issue?
In the case of a limited company, extra finance may be raised by issuing new additional shares in the company.
This is long term.
Adv - doesn’t have to be repaid and no interest is payable.
Disadv - profits will be paid out as dividends to more shareholders.
What is leasing?
Allows a business to obtain an asset e.g. company cars, without the need to pay a large lump sum up front. Leasing is similar to renting and is arranged through a finance company. Involves the business making regular payments to the finance company for the use of the asset.
This is medium term.
Adv - businesses can have the use of up to date equipment immediately.
Disadv - can be expensive as payments will include profits for the finance company.
What is hire purchase?
Allows a business to purchase assets without the need to pay a large sum up front. In the case of hire purchase the business pays an initial deposit and agrees to pay off the balance in equal instalments over a period.
Difference between this and leasing is when all repayments have been made the business owns the asset.
This is medium term.
What is a mortgage?
A loan from a bank or building society to purchase property. The sum borrowed plus interest charges has to be repaid in instalments over a long period. Business will own the property once the final payment has been made.
This is long term.
Adv - business has the use of the property from the beginning and can carry on its work there.
Disadv - expensive method compared to buying with cash due to interest charges.
What is trade credit?
Where suppliers allow their customers to have a period in which to pay for the goods they have received.
This is short term.
Adv - buyers have immediate use of goods and business can sell the goods first and pay later.
Disadv - discount given for cash payment would be lost.
What are government grants?
Most usual reason for this is to create employment in a depressed area and also given in order to attract foreign companies to invest in NI.
Can be given by Invest NI.
Assistance includes tax allowances or rates reduction.
Adv - do not have to be repaid.
Disadv - certain conditions may apply.
Factors affecting choice of source of finance
Purpose - what the finance is to be used for.
Time period - how long the finance will be needed for.
Amount - how much money the business needs.
Ownership of the business.
Size of the business.
