Sources of Finance

Sources of Finance

Sources of Finance Sources of Finance can be either: Internal External

Time Periods for Finance Finance is generally considered to be either: Short-term Medium-term Long-term 1 to 3 years 3 to 10 years Over 10 years

Internal Sources of Finance

Retained profits Retained profits are profits that the organisation has made in the past and has not given to owners in the form of profits or dividends. Personal savings For a sole trader or for partners, personal savings may be an important source of finance which can be brought into the business as additional capital. Internal Sources of Finance

Continued… Sale of fixed assets A business could sell off machinery, vehicles, land or buildings that it no longer needs in order to raise finance.

Continued… Reduction in working capital The business should try to reduce its stock so reducing working capital intake and the money it is owed by its debtors in order to raise more funds. Risks involved as liquidity of business decreases.

Continued… • Sale and lease back A business sells of its assets to a finance company that then leases the asset back to the business. This means that the business can obtain cash when it needs it, but still have the use of the asset.

Evaluation of internal sources of finance • This type of capital has no direct cost to the business. • Although, if the assets are leased back once sold, there will be leasing charges.

Short-term Trade Credit Bank Overdraft Debt factoring Medium-term Leasing and Hire purchase External Sources of Finance

Short term sources Bank overdraft • Flexible of all sources • Amount can vary from day to day. • Bank allows to overdraw from account by cheques • Highest interest charges • Business stability question

Short term sources Trade Credit: Usually in business dealing supplier give a grace period to their customers to pay for the purchases. This can range from 1 week to 90 days depending upon the type of business and industry. Advantage :No interest has to be paid. Dis advantage:The business may not get cash discounts By delaying the payment of bills for goods or services received, a business is, in effect, obtaining finance which can be used for more important expenditures.

Short term sources • Debt Factoring A factoring firm will buy a firms debts and assume the risk on non-payment. The factor collects the debts directly from the businesses customers. It involves the business selling its bills receivable to a debt factoring company at a discounted price. In this way the business get access to instant cash.

Medium Term Finance • Hire purchase: It involves purchasing an asset paying for it over a period of time. Usually a percentage of the price is paid as down payment and the rest is paid in installments for the period of time agreed upon. The business has to pay an interest on these installments. • Leasing: Leasing involves using an asset, but the ownership does not pass to the user. Business can lease a building or machinery and a periodic payment is made as rent, till the time the business uses the assets. The business does not need to purchase the asset.

Hire purchase and Leasing Advantages • The business can benefit from the asset without purchasing it. • Usually the maintenance of the asset is done by the leasing firm. Disadvantage The total cost of leasing may end up higher than the purchasing of asset

Long-term Finance Long term Loan Debentures Sale of Shares-equity finance Continued…

Long term Loan • Long term Bank loan: borrowing from bank for a limited period of time. The business has to pay an interest on the borrowing. This interest may be fixed or variable. Businesses taking loan will often have to provide security or collateral for the loan.

Debentures A debenture is defined as a certificate of acceptance of loans which is given under the company's stamp and carries an undertaking that the debenture holder will get a fixed interest rates and the principal amount whenever the debenture matures. It is issued for a long periods of time. Debentures are generally freely transferrable by the debenture holder. Debenture holders have no voting rights and the interest given to them is a charge against profit.

Sale of shares – Equity Finance • Issue of share: It is a permanent source of finance but only available to limited companies. Public limited companies can sell further shares up to the limit of their authorized share capital. Private limited companies can sell further shares to existing shareholders.

Sale of shares – Equity Finance Advantages Disadvantages Dividends have to be paid to the shareholders • Permanent source of capital. • No interest rate

Venture capital • Risk capital invested in business start ups or expanding small businesses that have good profit potential but do not find it easy to gain finance from other sources. • For unlisted small risky companies • Specialist org or wealthy people give it • Capitalist expect part of profit as return

Video sources of finance video

Finance for unincorporated businesses • What is un incorporated business?? • Micro finance

Finance and stake holders • Table 26.1 pg 485 • Activity 26.6 pg 486

Raising External Finance • The importance of business plan . • Table 26.2 pg 487

Sources of Finance