Unit 3 - Business Finance (Sources of finance) Flashcards
Why does a business need finance?
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.
Factors affecting the choice of finance
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.
Need for finance
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.
Expansion
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.
Internal source of finance
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
Personal savings
An entrepreneur will often invest personal savings, redundancy or inheritance money into a start-up.
Advantages of personal savings
- 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.
Disadvantages of personal savings
- The amount that is available may be limited, resulting in the entrepreneur having to use other sources of finance to fund the business.
Retained profits
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.
Advantages of retained profits
- 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.
Disadvantages of retained profits
- 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.
Selling assets
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.
Advantages of selling assets
- Using this method will mean that no finance needs to be repaid, and the business owners keep full control of the organisation.
Disadvantages of selling assets
- 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.
External sources of finance
Involves raising funds from outside the business.
- Overdraft
- Trade payable
- Credit cards
- Loan capital
- Share capital
- Venture capital
- Crowdfunding
Overdraft
An overdraft allows the business to withdraw funds from its account that are not there, up to an agreed maximum limit.
Advantage of Overdraft
- 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.
Disadvantages of Overdraft
- 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.
Trade payable
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.
Advantages of trade payable
- 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.
Disadvantages of trade payable
- 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.
Credit cards
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.
Advantages of credit cards
- Allows for short-term purchases when no cash is available.
Disadvantages of credit cards
- Must be paid back.
- High interest rate charged.
