Sources Of Finance

Sources Of Finance

1. Internal

   • Owner's Investment
     • Money from the owners own savings / financial resources.
       • Adv: Doesn't have to be repaid; No interest
       • Disadv: Limit to the amount an owner can invest
     • Start-Up or Additional Capital
     • Long Term
   • Retained Profits
     • When profits are ploughed back into the business
       • Adv: Doesn't have to be repaid; No interest
       • Disadv: Not available to new businesses; may not make enough to plough back
     • Only available if the business has been trading for more than 1 year
     • Medium or long term
   • Sale of Stock
     • Money comes in from selling off unsold stock
       • Eg. January Sales
       • Adv: Quick way of raising finance; Reduces costs associated with holding stock
       • Disadv: Must take reduced price for stock
     • Short Term
   • Sale of Fixed Assets
     • Medium Term
     • Do not always have fixed assets which need to be sold
     • Limit to number of fixed assets a firm can sell off
     • Selling of, e.g, machinery which is no longer needed
       • Adv: Raise finance from an asset which is no longer needed
       • Disadv: Unlikely to have surplus assets; Can be a slow method
   • Debt Collection
     • A trade receivable (debtor) is someone who owes the business money
       • Not all businesses have, ie. those who deal only in cash
     • A business can raise finance by collecting the money owed to them (debts) from their trade receivables
       • Adv: Not additional cost in getting finance- part of normal operations
       • Disadv: Risk that debts owed can go bad and not be repaid
     • Short Term

2. External

   • Bank Loan
     • Medium or Long Term
     • Money borrowed at an agreed rate of interest over a set period of time
       • Adv: Set repayments are spread over a period of time --> good for budgeting
       • Disadv: Can be expensive due to interest; Bank may require security on loan
   • Bank Overdraft
     • Where the business is allowed to be overdrawn on its account up to an agreed limit
       • Adv: Good way to cover the period between money going out of and coming into a business; If used short term it is cheaper than a bank loan
       • Disadv: Interest payable on amount overdrawn; can be expensive if used over a longer period of time
     • Short Term
     • They can still write cheques, even if they do not have enough money in the account
   • Additional Partners
     • New partner(s) can contribute extra capital
       • Adv: Doesn't have to be repaid; No interest
       • Disadv: Diluting control of the partnership; Profit will be split more ways
     • Partnership
   • Share Issue
     • Involves issuing more share
       • Adv: Doesn't have to be repaid; No interest
       • Disadv: Profits will be paid out as dividends to more shareholders; ownership of the company could change hands
     • Long Term
     • Limited Company
   • Leasing
     • Medium Term
     • Involves making set repayments
     • Allows a business to obtain assets without the need to pay a large lump sum up front
       • Adv: Businesses can have the use of up to date equipment immediately; Payments are spread over a period of time --> good for budgeting; The finance company will pay for maintenance of the asset
       • Disadv: Can be expensive; the asset belongs to the finance company
     • Arranged through a finance company
     • Like renting an asset, ie. you never own it
   • Hire Purchase
     • Allows a business to obtain assets without the need to pay a large lump sum up front
       • Adv: Businesses can have the use of up to date equipment immediately; Payments are spread over a period of time --> good for budgeting; Once all repayments are made the business will own the asset
       • Disadv: Expensive method compared to buying with cash
     • Involves paying an initial deposit and regular payments for a set period of time
     • The main difference between hire purchase and leasing is that with hire purchase after all repayments have been made the business owns the asset
     • Medium Term
   • Mortgage
     • A loan secured on property
       • Adv: Business has the use of the property; Payments are spread over a period of time --> good for budgeting; Once all repayments are made the business will own the asset
       • Disadv: Expensive method compared to buying with cash; If business does not keep up with repayments the property could be repossessed
     • Long term
     • The business will own the property once the final payment has been made
     • Repaid in insalments over a period of typically 25 years
   • Trade Credit
     • 'Buy now, pay later'
       • Adv: Businesses can sell the goods first and pay for them later; Good for cash flow; No interest charged if paid within agreed time
       • Disadv: Discount given for cash payment would be lost; Businesses need to carefully manage their cash flow to ensure they will have money available when the debt is due to be paid
     • Short Term
     • Typical tradde credit period is 30 days
   • Government Grants
     • Government organisations such as Invest NI offer grants to businesses, both established and new
       • Adv: Don't have to be repaid
       • Disadv: Certain conditions may apply, eg. location; Not all businesses eligible for a grant
     • Usually certain conditions apply, such as where the business has to be located

3. Factors Affecting Choice

   • Purpose: What the finance is to be used for
   • Time Period: How long the finance will be needed for
   • Amount: How much money the business needs
   • Ownership and Size of the business