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5.1 Business finance - Needs and sources - Coggle Diagram
5.1 Business finance - Needs and sources
Why businesses need finance?
Sources of finance are where and how a business gets the money it needs to trade, grow, and survive.
Money is needed for working capital, for expansion, and to get started
Uses of finance in a business
Capital expenditure
Money spent in purchasing fixed assets, that business will use for more than a year.
Revenue expenditure
Money used to cover short-term day-to-day expenses and to help generate sales.
Term finance needs
Short term
Less than 1 year.
Used to fund revenue expenditure and are repaid within a year.
Long term
5+ years.
Used to fund capital expenditures and is repaid over a period longer than a year.
Main sources of capital
Where businesses get money.
Internal finance
Money obtained from within the business.
External finance
Money obtained from sources outside business.
Sources categorized by...
Debt
Involves using money that must be repaid, plus interest.
Equity
Raising money by selling shares in the company, also refers to owners’ funds (or private equity).
Willingness depends on availability and price of debt. Price of debt is determined by how much interest is charged on the loan.
Internal sources of finance
Are those generated by business itself.
Owners' funds
Sold traders or members of a partnership may inject more of their own money into the business.
Retained profit
Profit can be used as a source of finance. It's available if the business makes a profit and if the owner doesn't want to keep profit for themselves.
Working capital
Is money available for immediate use to fund day-to-day operations.
Sales of assets
Firm could sell buildings, vehicles or parts of its business as a way to generate funds.
Have the benefit of being inexpensive and convenient (easy and quick to access).
External sources of finance
Are grouped according to the time frame over which they are most often used.
Overdrafts
Banks allow to draw out of accounts more money than it is deposited. Often used to cover cash shortages and may be overdrawn for a matter of days. Interest is only paid when the account is overdrawn.
Trade credit
Business-to-business transactions are completed on a credit basis. Business does not pay immediately for the goods it purchases; instead it must give days to pay. This credit period gives time to sell goods and generate funds to pay suppliers.
Debt factoring
Involves “selling” debt to a debt factoring company. These companies give to firms a % of debt and will attempt to recover full debt for themselves. Business gets access to cash but may forego the full value of the debt. In return, the debt factoring company retains a % of recovered debt.
Leasing
Leasing an asset instead of purchasing it, business reduces the amount of finance it needs to raise.
Hire purchase
Gives the benefit of owning the asset once it has made all monthly payments. Make hire purchase cheaper than leasing, but without the benefit of flexibility.
Bank loans
Repaid on a monthly basis over a number of years. Bank charges interest on the loan amount.
Sale and leasebacks
Use to resolve short-term cash flow crisis. Use as a way of funding long-term growth. Business sells an asset and leases it back from its new owner. Generates an inflow of cash at the expense of long-term lease payments.
Ventures
Start-up business is unable to raise funds, often uses venture capital. Inexperience owners, support from ventures capitalist can be useful.
Debentures
Form of long-term loan to a limited company. They fix interest rates and are repayable over a specified time period (15-25 years).
Grants
Government offers grants to businesses. Are available for businesses setting up in certain locations, producing certain products or creating employment opportunities.
Factors affecting choice in finance
Availability of internal funds
Control
Time
Cost
Current financing
Types of business
Security