1. Sources of Finance tutor2u GCSE Business Studies Revision Presentations 2004

2. Reasons a Business Needs Finance

Start a business

Finance new technology

Open new markets

Acquisitions

Moving to new premises

Day to day running of business

3. Internal and External Sources

Internal Sources of Finance

• Come from trading of business

• Day to day cash from sales to customers

• Money loaned from trade suppliers through extended credit

• Reductions in amount of stock held by business

• Disposal (sale) of any surplus assets no longer needed (e.g. selling a company car)

External finance

• Comes from individuals or organisations who do not trade directly with business

• E.g. banks, investors. government

4. Short and Long-term Finance

Short term finance

• Needed to cover day to day running of business

• Paid back in a short period of time, so less risky for lenders

Long term finance

• Tends to be spent on large projects which will pay back over a longer period of time

• More risky so lenders tend to ask for some form of insurance or security if company is unable to repay loan.

• A mortgage is an example of secured long-term finance

5. Main Sources of Long-term Finance

Mortgages

Bank loans

Share issues

Debentures

6. Criteria for Choosing a Source of Finance

Amount of money required

How quickly money is needed

Cheapest option available

Amount of risk involved in reason for cash

7. Using Own Cash to Start a Business

Own cash is cheapest form of finance since it carries no obligation to pay any interest

Dont need to give any control of business to any other party

More flexible than other sources

• No authorisation hurdles to overcome

• Can add more finance if required (and available)

• Various tax incentives for people who invest in their own business

8. Sources of Finance for Sole Traders and Partnerships

Bank loans

Bank overdraft

Trade credit

Retained profits

Taking on a new partner

Government grants (depending on area and activities

Remember there is no company; so a sole trader or partnership cannot have shareholders providing finance

9. Share Issues

Two types of limited company that define the way that money can be raised through shares.

• Aprivate limited companycan sell shares only to designated people and there is a limit how much capital they can raise through this method

• Apublic limited companycan issue shares to the public.This means anyone can have a share in the company

Finance raised by a company by selling new shares to shareholders

Unlike a loan money does not have to be repaid over a fixed period of time

Note: when one shareholder sells shares to another, the company does not raise any additional funds since no new shares have been issued

10. Ordinary Shares and Preference Shares

Ordinary shares

• The most common form of share capital

• Ordinary shareholders can vote at company meetings

• Amount of dividend received varies

Preference shares

• Shareholders do not have a vote at company meetings

• Dividend is usually fixed (e.g. 5% of value of shares held paid as dividendeach year)

• Shareholders receive their dividend before ordinary shareholders

11. Return on Investment for Ordinary Shareholders

Comes in two parts:

• Dividends - paid out on each share held by company

• Increases in value of each share as company itself grows in value (capital gain)

Note 1: a shareholder only actually realises a gain on the increased value of a shareholding when those shares are sold.Otherwise it is just a gain on paper

Note 2: Companies do nothaveto pay out dividends

• There may be no profit available (dividends can only be paid out of profits)

• The shareholders may wish to reinvest profits in the business rather than take cash out

12. Debentures

Source of long term finance

In the form of a loan

Usually secured against an asset

Repayable at a fixed date

Fixed rate of interest

13. Difference between Debentures and Ordinary Shares

Lender has no voting rights in company

Loan attracts interests whereas holders of ordinary shares get dividends

Providers of loans are paid out before ordinary shareholders in event that business fails (assuming there is some cash left)

14. Finance Available from a Bank

Bank overdraft

Bank loans

Asset finance (leasing)

15. Bank Overdrafts and Bank Loans

Bank overdraft

• Limit on borrowing on a bank current account

• Amount of borrowing may vary on a daily basis

• Technically repayable on demand by the bank

Bank loan

• Fixed amount for a fixed term

• Regular fixed repayments

• Interest on a loan tends to be lower than an overdraft

• Normally a fixed term loan will be for a greater amount than an overdraft

16. Working Capital

Amount of short term capital available for day to day running of business

Expressed as current assets less current liabilities e.g. value of debtors and stocks less creditors

Working capital normally needs to be funded

• E.g. the value of stocks and trade debtors is more than the value of trade creditors

17. Debt Factoring

Business sells its outstanding customer accounts (those who have not paid their debts to business) to a debt factoring company

Factoring company pays business face value of debts less a charge (e.g. 15-20%), but then collects full amount of debts for itself

Good way of raising cash quickly, without hassle of chasing payments

BUT not so good for profits since it reduces total revenue received from those sales

18. Government Grant Funding

Protect jobs in failing/declining industries

Help create jobs in areas of high unemployment

Help start up new businesses

Help businesses relocate to areas of high unemployment

Examples

• European Structural Fund

• Assisted Areas

• Regional Selective Assistance

19. Leasing

What is involves

• Like renting a piece of machinery/equipment

• Business pays a regular amount for a period of time

• Items belong to leasing company

Advantages

• Cheaper in short run than buying a piece of equipment outright

• If technology is changing quickly or equipment wears out quickly it can be regularly updated or replaced

• Cash flow management easier because of regular payments

Disadvantages

• More expensive in long run, because leasing company charges fees which make total cost greater than original cost

20. Hire Purchase

Business hires equipment for a period of time making fixed regular payments

Once payments have finished it then owns piece of equipment

Different to leasing in that business owns equipment when it has finished making payments

21. Sources of Finance for Public Sector Businesses

Tax revenue from government, usually paid out in form of grants or subsidies

Fees paid by public or businesses e.g. trading licences

E.g. In case of BBC, money from TV licence