Unit 3 - Business Finance (Sources of finance)

Question 1

Why does a business need finance?

Answer 1

A start-up or existing small business will need finance to fund start-up costs.
As a business grows, it will need to raise finance to fund running costs.

Question 2

Factors affecting the choice of finance

Answer 2

The source chosen by a business will depend on:
- The amount needed
- The reason why the finance is required
- How quickly the finance is needed
- How long the finance is needed for
- The circumstances of the business
- The legal status the business has
- Is the entrepreneur prepared to give up ownership and control of the business.

Question 3

Need for finance

Answer 3

Short term: Finances to cover day to day expenses. Paid back in less than a year.
Long term: Capital used for long term expenses. More than a year to pay back.
Start-up capital: One off expenses at start of the business.

Question 4

Expansion

Answer 4

Once a business is established, owners often want to grow and expand.
- Increase capacity
- New products
- Diversity
- Expand overseas
Businesses need finances to fund any expansion.

Question 5

Internal source of finance

Answer 5

Involves raising funds from within the business. Often limited but business won’t have to pay it back to external sources.
- Personal savings
- Retained profits
- Selling assets

Question 6

Personal savings

Answer 6

An entrepreneur will often invest personal savings, redundancy or inheritance money into a start-up.

Question 7

Advantages of personal savings

Answer 7

• Provides a strong signal to other potential investors and the bank of the entrepreneur’s commitment to the business.
• It is interest free.
• Available quickly.
• Maximises the control the entrepreneur keeps over the business.

Question 8

Disadvantages of personal savings

Answer 8

• The amount that is available may be limited, resulting in the entrepreneur having to use other sources of finance to fund the business.

Question 9

Retained profits

Answer 9

When a business has worked out its profits, the owners or shareholders can decide whether to take the profits for themselves or reinvest the profits back into the business.

Question 10

Advantages of retained profits

Answer 10

• A cheap form of finance, as no interest has to be paid.
• Flexible - business owners have complete control over how many profits are reinvested and the proportion that is kept in the business, rather than paid out as dividends.

Question 11

Disadvantages of retained profits

Answer 11

• If a business needs some temporary finance because it is facing difficulties, then it may not have any profit that it can use.
• Growth may be slow if it is dependent on retained profits, as profits may not be high enough to finance the growth quickly.
• Using too many profits in the business, may upset shareholders who may feel that their dividend payments are too low.

Question 12

Selling assets

Answer 12

Selling spare or unwanted non-current assets, such as spare land, buildings, machinery or equipment that are no longer needed by the business, can result in extra finance being generated on an one off basis.

Question 13

Advantages of selling assets

Answer 13

• Using this method will mean that no finance needs to be repaid, and the business owners keep full control of the organisation.

Question 14

Disadvantages of selling assets

Answer 14

• Unlikely to be a long-term solution.
• Reduces the value of the business.
• Is unlikely that the business will gain the value that it originally paid for it, due to depreciation.

Question 15

External sources of finance

Answer 15

Involves raising funds from outside the business.
- Overdraft
- Trade payable
- Credit cards
- Loan capital
- Share capital
- Venture capital
- Crowdfunding

Question 16

Overdraft

Answer 16

An overdraft allows the business to withdraw funds from its account that are not there, up to an agreed maximum limit.

Question 17

Advantage of Overdraft

Answer 17

• Offers flexibility
  -Important source of finance for a business if it has a short-term shortage of cash or unexpected cost to pay.
• Interest is only paid on the amount used.

Question 18

Disadvantages of Overdraft

Answer 18

• Repayable to the bank at any time.
• A bank may lower or even withdraw the overdraft facility at any time.
• Usually has high levels of interest, using overdrafts is therefore an expensive form of finance.

Question 19

Trade payable

Answer 19

Trade payable (Trade credit) is provided by a firm’s suppliers, allowing the business to have the goods now and pay for them at a later date.

Question 20

Advantages of trade payable

Answer 20

• This can allow the business to use the goods in the manufacturing process and/or sell the goods before it pays the suppliers, which will improve its cash-flow position.

Question 21

Disadvantages of trade payable

Answer 21

• Danger of bad reputation and losing future credit arrangements with the supplier if bills are not paid on time.
• Difficult for new start-up businesses to negotiate trade credit with suppliers, as there is a risk that the business will fail, and suppliers may end up not getting paid.

Question 22

Credit cards

Answer 22

A credit card allows you to pay for goods by borrowing money from the credit card provider. The credit card provider will charge you interest to do so.

Question 23

Advantages of credit cards

Answer 23

• Allows for short-term purchases when no cash is available.

Question 24

Disadvantages of credit cards

Answer 24

• Must be paid back.
• High interest rate charged.

Question 25

Loan capital

Answer 25

A bank loan is an amount of money borrowed for a set period with an agreed repayment schedule and repaid in instalments over a number of years plus interest.

Question 26

Advantages of loan capital

Answer 26

• Guaranteed the money for a certain period.
• No control is lost.
• Interest rates may be fixed for the term, making it easier for an entrepreneur to forecast interest payments and cash flow.
• Repayments are made in installments.

Question 27

Disadvantages of loan capital

Answer 27

• Time consuming - business would need to produce a detailed business plan.
• Security/collateral needed.
• Lack of flexibility.
• Interest must be paid on the full loan.

Question 28

Share capital

Answer 28

Small or new businesses that are set up as private limited companies can raise finance by selling shares in the company.
Alternatively, large public limited companies can raise large amounts of funds by issuing new chares for sales.

Question 29

Advantages of share capital

Answer 29

• Large sums of money can be raised.
• Capital does not have to be repaid.
• There is no interest.

Question 30

Disadvantages of Share capital

Answer 30

• Possible loss of control if the original owners sell more than 50%.
• Need to satisfy shareholders expectations of dividends and share price growth.

Question 31

Venture capital

Answer 31

Venture capitalist are specialist investors who provide money for business purposes, often to new businesses.

Question 32

Advantages of Venture capital

Answer 32

• Entrepreneur can offer advice and guidance.
• Giving up some ownership.
• Conflicts can arise.
• Excessive influence.

Question 33

Crowd funding

Answer 33

Method of raising finance online. Businesses outline the details of their business and projects and invite people to help to provide funding.

Question 34

Advantages of Crowd funding

Answer 34

• Ability to raise finance from a large number of investors.
• No interest paid.

Question 35

Disadvantages of crowd funding

Answer 35

• Possible partial loss of ownership.
• No guarantee of sufficient investment.