sources of finance Flashcards
short term finance
Used to maintain positive cash flow and get through periods of poor cash flow for seasonal reasons (ice cream seller in winter), bridge the gap when a large payment is delayed, leaving the business without enough money to pay its bills and provide extra cash to pay for the manufacturing required to meet sudden or unexpected changes in customer orders.
Overdraft
one of the most common but they should be used carefully and only in emergencies as they can become expensive due to the high interest rates charged by banks.
Common features of a bank overdraft include:
variable interest rates - the cost of borrowing money will change when the interest rate changes
flexibility - a business uses its overdraft only when it needs to, therefore the business will only pay interest when the overdraft is used the bank can demand full payment - banks can demand full repayment of an overdraft within 24 hours
Trade credit
must be agreed with a supplier and forms a credit agreement with them. This source of finance allows a business to obtain raw materials and stock but pay for them at a later date. The payment is usually made once the business has had an opportunity to convert the raw materials and stock into products, sell them to its own customers, and receive payment.
Common terms and conditions of a credit agreement include:
credit limit - the maximum amount of credit available to the business
credit period - the length of time the business has to pay what is owed, usually 30, 60 or 90 days
frequency of payment - how often payment is required, usually monthly
method of payment - the way in which the business makes payment (eg bank transfer, cheque or card payment)
retrospective discount - a discount given when the business has purchased a certain amount of stock or raw materials
Long term finance
personal savings, venture capital, share capital, bank loan, retained profit, crowdfunding
personal savings
is money that has been saved up by an entrepreneur. This source of finance does not cost the business, as there are no interest charges applied.
venture capital
is money invested by an individual or group that is willing to take the risk of funding a new business in exchange for an agreed share of the profits. The venture capitalist will want a return on their investment as well as input into how the business is run.
Share capital
is money raised by shareholders through the sale of ordinary shares. Buying shares gives the buyer part ownership of the business and therefore certain rights, such as the right to vote on changes to the business. This can slow down decision-making processes. Shareholders cannot have a refund on their shares. Instead, if they want to sell their shares, they must find someone else to sell them to.
There are no dividends to be paid if the business has a poor year – Shareholders are not promised dividends every year, as dividends are only paid if the business has made sufficient money to pay all of its costs.
Disadvantages of share capital include:
It dilutes control for the founders – The more shares that are issued, the more shareholders there are who own part of the business. This results in the founders having less control. In order to have a majority stake in the business, the founders must hold more than 50 per cent of the shares.
The business is vulnerable to takeover – As a business grows and sells more shares, it becomes vulnerable to the threat of a takeover. This is because the shares are sold publicly and if an individual or group buys enough shares, they can persuade other shareholders to vote for a new management team
Bank loan
A bank loan is money lent to an individual or business that is paid off with interest over an agreed period of time. Usually this rate of interest is fixed. This means that the business knows in advance what the cost of borrowing will be and what monthly repayments will be required. This allows the business to plan ahead.
To get a bank loan, a business must apply to a bank. The bank then carries out credit checks to see the financial history and reliability of the applicant. The bank may require the business to secure its assets against the loan. This means that if the business is unable to repay the loan, the bank can demand the sale of the assets to raise money to pay back the loan. If a business does not have enough assets, a bank may require a guarantor to repay the loan if the business does not make its repayments on time.
Retained profit
When a business makes a profit, it can leave some or all of this money in the business and reinvest it in order to expand. This source of finance does not incur interest charges or require the payment of dividends, which can make it a desirable source of finance.
Crowdfunding
involves a large number of people investing small amounts of money in a business, usually online. Commonly used crowdfunding websites include Crowdfunder, GoFundMe and Kickstarter.
Advantages of crowdfunding include:
It acts as a form of market research. If people don’t invest, it means the business idea is not attractive or distinctive enough, indicating that the business is likely to fail.
It provides opportunities for individuals to start up a business even if they don’t have access to other sources of funding.
Disadvantages of crowdfunding include:
The business must be interesting. Crowdfunding is most successful when the business idea is appealing, interesting and innovative.
It can be difficult to reach the funding target. Statistics from crowdfunding websites indicate that less than 33 per cent of businesses achieve their funding target.
