AS Business UNIT 1

FINANCE

Learning Objectives

To understand the reasons why a business may need additional finance

To be able to identify the different sources of finance

To know the advantages and disadvantages of each source of finance

Sources of Finance

Why do businesses need finance?

Task

On a piece of paper, in pairs list the reasons why a business might

need finance

Why do Businesses Need Finance?

Pay a large bill

Expansion

Shortage of funds

Assist with day-to-day running Buy new

equipment

Moving to new premises

Internal growth

Task: Government grants

Types of Finance

Finance can come from a number of different sources:

Internal – from within the business

External – from outside the business

Not all sources are available to every business - why?

Finance and Time

The length of time for which a business needs finance is known as a time period

Businesses may require finance for different lengths of time – these are usually called short, medium and long term

Time Period Short-term (Up to 12 months)

Medium-term (1-3 years)

Long-term (3 years or more)

Internal Source of Finance

Cash in bank Retained profit Retained profit

Sale of assets Owners investment

Internal Finance

Internal Finance is money from within the business

There are no costs to the business associated with internal finance, the business is using its own money

However, there is an opportunity cost involved

External Finance

External Finance is money from outside the business

There will always be some cost involved – usually this is interest

In some cases security in the form of an asset owned by the business, of similar or greater value, has to be offered to the lender of the money

Providing security for a loan means that in the event of the business being unable to pay back the loan, ownership of the asset transfers to the lender

Trade credit

When one business trades with another they will sometimes need to “buy” goods with trade credit

The seller gives the buyer 30, 60, 90 days to pay

The buyer then has time to sell the goods in their own shop before they have to pay for them

The wholesaler may give the buyer a discount when they use cash instead

Buy Now pay laterBuy Now pay later

Venture capital

Venture capital is also known as private equity finance. Venture capitalists (VCs) will invest large sums of money in a business in return for shares in the company.

Typically, VCs will invest at least £50 000 in a small regional business although this can rise into millions of pounds.

The VC will look for a high rate of return in a specific time period.

They look for a strong business plan, sound management and a proven track record, making it difficult for start-up firms.

http://www.investopedia.com/video/play/venture-capital/

http://www.bbc.co.uk/programmes/b006vq92

Bank Loan

Loaning money from a bank is like “renting” the money

Banks will lend to small business but may not lend when they first start-up as there is no track record or history of them making money.

Loans are quick to set up Loans are affected by interest rates – if they

go up the cost of borrowing will go up too and the business may have to pay more interest back to the bank

A bank will want to see a business plan so they know how their money will be paid back.

A bank will charge interest on the loan

A bank will ask for security or collateral on a loan this may be a house or another asset that can be seized if the loan is not paid back

Overdraft

Some months a business may need extra cash to tide it over until a better month. A loan is over many years so is not suitable.

An overdraft may be organised by the bank which is short term lending of smaller amounts of money

Very high charges and interest rates for an overdraft Once its arranged (say £2,000) on an account a business can

dip into it or pay it back as they see fit If the business goes over this amount the overdraft will be

“unauthorised” and the business will be charged heavily Very expensive source of finance

In the graph in Jan and Feb the business would need to borrow from an overdraft until there was

an income in March

Sale of assets

A business can raise finance by selling items that they already own.

This could be:

Machinery

Land

Premises

Vehicles

The business that sells the asset will no longer have the benefit of that asset and it will not appear on the balance sheet of the company – meaning the business will look less attractive to investors

Internal source of finance

Retained profits

After a year or more of trading a business may have some profits that they are able to re-invest into the business to help it grow.

A well run business should continually re-invest in new staff / equipment / stock/ premises / vehicles etc

If a business is in its first year of trading it will NOT have any retained profits – as it will not have made any to retain.

The advantage is there is no interest to pay.

The disadvantage is once it is used it has gone. This is an internal source of finance.

Internal source of finance

Ordinary share capital

In a public limited company (one that has been floated on the stock market) they can raise more finance to expand by having an ordinary share issue.

This is an external and long term method of finance but would only apply to a large business with a plc after its name.

Lease As a business grows it may decide that it needs some more

vehicles or equipment.

They may decide to lease so that the equipment can be updated regularly.

They will NEVER own the equipment but will get the option to change it when it wears out.

Examples are photocopiers and vans

Hire purchase A business may wish to expand

and may need a vehicle or some equipment in order to grow.

Some business machinery is very expensive – so they may decide to use HP

The business will pay for the equipment over a fixed amount of time (say 5 or 10 years) and at the end the equipment is theirs to keep.

This will be cheaper method than a bank loan plus the business will know what their fixed costs are each month as the amount they have to pay back will not change.

Friends and family Private limited companies are able

to raise finance by selling shares to friends and family.

A sole trader or partnership may also find that their family may want to contribute to the business. This may be for interest, a share of the profits or maybe even an interest free loan amongst family.

The benefit of this is the owner may still keep control of the business and may be better able to trust their business investors.

Downside is that it may cause tension and problems if the finance is not repaid or the business does not flourish.

Cake boss:

https://www.youtube.com/watch?v=SEuJfekCh0w

Internal source of finance

Task – Levi Roots

Starter – Key Term test

1.Asset

2.Venture Capital

3.Loan Capital

4.Overdraft

5.Retained Profit

Resources

Businesses provide us with our WANTS andWANTS and NEEDSNEEDS by processing inputs into outputs

Inputs:Inputs: these are raw materials which a business uses.

Outputs:Outputs: are the goods and services which a businesses produces to sell to potential customers

Factors of Production Businesses use resources known as Factors ofFactors of ProductionProduction

to satisfy the customers wants and needs

The factors of production are broken down into fourfour main sections

1. Land

This includes all raw materialsraw materials a business uses to produce products. It refers to raw materials such as:

Fishing

Farming

Mining

Quarrying

Forestry

2. Labour

This is the use of human skillshuman skills to take the raw materials and change them into products

Physical labour is when people use their hands

For example: chef, builder

Mental labour is when they use their minds

For example: solicitor, teacher

3. Capital

Capital resources are those items which have been produced by people to assist the production processproduction process

For example:

A screwdriver

A machine

A factory

4. Enterprise

Entrepreneurs are individuals who bring together and organise the factors of production to produce goods and services for the customer.

These people set out to meet the needs and wants of people and in turn make money.

Task Place the following resources under the heading land, labour,

capital or enterprise

ShareholderComputerCarpenterVanBoltscrewdriver

DoctorForestCoalShopOwner of a corner shop

Task – exam style questions

Explain the difference between internal finance and external finance (4 marks)

Identify three sources of short-term finance (3 marks)

Describe the main differences between a bank loan and a bank overdraft (6 marks)

Explain two reasons why a firm might decide to use internal finance rather than external finance (6 marks)

Learning Outcomes

You should now be able to:

Explain the reasons why a business may need additional finance

Identify the different sources of finance

State the advantages and disadvantages of each source of finance