Sources Of Finance Flashcards
Internal finance
Internal nance refers to funds that are generated from within the rm itself; that is, from owner’s equity. This could consist of the owner contributing more capital or using retained pro ts to nance business operations.
2 internal sources of finance
Capital contribution
Retained earnings
Pros and cons of capital contribution
Advantages:
• no set repayment date
• no interest charge.
Disadvantages:
• limited to the resources of the owner.
Retained earnings
an internal source of nance consisting of funds generated from business pro ts that are not taken as drawings by the owner
Pros and cons of retained earnings
Advantages:
• no set repayment date
• no interest charge.
Disadvantages:
• limited to previous pro ts (which may not exist!)
4 external sources of finance
Trade credit
Bank overdraft
Term loan
Leasing
External finance
External nance refers to funds that are sourced from outside the business; that is, from liabilities. This includes various forms of borrowing such as using a bank overdraft, trade credit, a lease or a loan.
Trade credit and creditors
Trade credit refers to the facility offered by suppliers that allows its customers to purchase goods or services immediately, and then pay at a later date. As a result of a credit purchase, the supplier becomes a creditor of the rm making the purchase, because the purchasing business has not yet paid for the goods or services. Credit terms can be 30, 60 or even 90 days, with the due date for payment speci ed on the purchase invoice which accompanies the goods/services.
Pros and cons of trade credit
Advantages:
• allows immediate access to goods/services
• allows businesses time to generate sales before payment is required
• no interest charge if credit terms are met
• discounts are available from some suppliers for early payment. Disadvantages:
• trade credit can only be used for purchases with that supplier
• interest charges and late fees may be incurred for late payment (if stated in credit
contract).
Bank overdraft
A bank overdraft is a facility provided by a bank (or other nancial institution) that allows a business to withdraw funds greater than the current balance of its account. The amount overdrawn is then owed to the bank. This type of nance (normally attached to a cheque account) can provide a safety net for rms that have irregular cash ows, with most banks happy for the account to remain overdrawn as long as it does not exceed the overdraft limit. Although an overdraft represents a readily accessible form of nance, it usually incurs a high interest rate (compared to other loans), which is calculated on a daily basis.
Term loan, security, mortgage
Term loans are funds provided by a bank or other lender for a speci c purpose, and repaid over time. Increasing the length of the loan may reduce the amount of each instalment, but will usually increase the total amount repaid over the term of the loan. In some cases, the lender will require that the loan is secured against a particular asset (this security is usually the asset for which the loan is obtained) so that if the borrower defaults on the loan, the lender is entitled to claim that asset to settle the debt. A mortgage is a speci c type of term loan that is secured against property. Unsecured loans usually attract a higher interest rate to compensate for the higher risk accepted by the lender.
Pros and cons of term loan
Advantages:
• makes possible the purchase of expensive assets
• exible – can be used for a variety of purposes
• secured loans attract a lower interest rate.
Disadvantages:
• interest charges
• requires commitment by business to make repayments for the term of the loan
• principal and interest repayments can put pressure on cash ows.
Lease, lessee, lessor
A lease is a form of rental agreement that allows a business to use and control an asset for a length of time in return for speci c periodic payments, and is very useful for assets that need to be replaced frequently. The business applying for the lease is known as the lessee and the business granting the lease is known as the lessor. The lessee has full control of the asset for the period of the lease agreement; however, it will never own the asset.
Pros and cons of leasing
Advantages:
• reduces initial outlay to acquire assets
• makes it possible to obtain technologically advanced assets
• allows assets to be updated when they become outdated or technologically
obsolete; for example, computers
• reduces maintenance and repair costs.
Disadvantages:
no ownership of asset
requires commitment by business for the term of the lease.
Pros and cons of bank overdraft
Advantages:
• readily accessible
• exible – can be used for a variety of purposes. Disadvantages:
• high interest charge
• can be recalled at short notice.
