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Sources of Finance - Coggle Diagram
Sources of Finance
External Sources of Finance
Owner's capital: This is money invested in the business from the owner's personal savings.
Owner's Capital Advantages: No interest payments or need to repay. High level of commitment from the owner.
Owner's Capital Disadvantages: Amount available is likely to be limited. If there is more than one owner this could cause friction if everyone is not able to contribute the same amount.
Loans: Loans are money borrowed from a financial institution normally for a set period of time and for a specific purpose.
Loans Advantages: Can be arranged quickly. Loan can be repaid over a long period of time. Ownership or control is not lost. Regular pre-agreed repayments make planning and budgeting relatively easy.
Loans Disadvantages: Interest is charged on the amount borrowed. Interest rates can fluctuate. Often secured against an asset that can be seized if repayments are missed. Interest has to be paid regardless of whether a profit is being made.
Crowd-funding: This involves attracting investment from a large number of speculative investors many of whom may invest relatively small amounts. If cumulatively this matches the required amount then the investments are collected together. Normally uses the internet to attract investors.
Crowd-funding Advantages: Access to large amount of investors. Fast way to raise finance. No interest paid as investors will only be rewarded if the business is successfully sold on at a later date.
Crowd-funding Disadvantages: Partial loss of ownership. No guarantee that the crowd fund will attract sufficient investment to meet the proposal.
Mortgages: These are long-term loans, normally around 25 years, that are secured against a specific asset, for example a building. Interest will be payable on the mortgage.
Mortgages Advantages: Large amounts of finance can be raised and repaid over a prolonged period of time. Ownership or control is not lost.
Mortgages Disadvantages: Interest is charged on the amount borrowed. Interest rates can fluctuate. Often secured against an asset that can be seized if repayments are missed. Interest has to be paid regardless of whether a profit is being made. Not suitable for small amounts or as a short-term source of finance.
Debt Factoring: Debt factoring is a short term source of finance where firms sell their invoices to a factor such as a bank. They do this for some cash right away, rather than waiting 28 days to be paid the full amount.
Debt Factoring Advantages: Time and effort is saved as the company is no longer required to recover unpaid debts. Speeds up the flow flow of cash into the business from debts.
Debt Factoring Disadvantages: Money is lost from the business as unpaid debts are sold at a reduced value. Only receive a percentage of the amount owed, therefore reducing profits. Can give the wrong impression or alienate customers.
Venture Capital: Venture capital is money that investors provide to a company that is starting up or expanding. Venture capital is usually used when there is an element of risk with the business.
Venture Capital Advantages: Finance is provided by a business professional who will often offer advice and mentoring alongside the investment. Venture capitalists are often risk-takers and may see the potential in a high-risk investment that other investors including banks may not be willing to invest in.
Venture Capital Disadvantages: Venture capitalists may want a share of the business, meaning some control may be lost. A larger return may be required due to the high risk nature of the investment.
Hire Purchase: This involves paying to use an asset in installments to spread the cost over its useful life and hence provide a source of finance. The asset will remain the property of the seller until the final installment has been paid.
Hire Purchase Advantages: Avoids the need to pay a lump sum for the use of an asset. Regular installments make planning and budgeting easier. Spreads the cost of an asset over its useful life.
Hire Purchases Disadvantages: Overall amount paid for the use of an asset is likely to be higher than if purchased outright. Only really suitable for relatively low cost assets, e.g. vehicles and not premises.
Leasing: This involves paying to use an asset in installments to spread the cost over its useful life and hence providing a source of finance.
Leasing Advantages: Responsibility for maintaining and repairing the asset stays with the supplier. Spreads the costs of an asset over its life to avoid paying a lump sum up front.
Leasing Disadvantages: Overall amount paid for the use of an asset is likely to be higher than if purchased outright. Never actually own the asset and therefore payments are ongoing.
Trade Credit: This is a period of time offered by suppliers to allow the customer to purchase a good or a service now and pay at a later date, for example 30 days after purchase.
Trade Credit Advantages: Delays the need to pay for goods and services purchased, therefore aiding cash flow. No loss of ownership or control.
Trade Credit Disadvantages: Potential loss of discounts offered for cash payments. Only suitable as a short-term source of finance.
Grants: This is a lump sum provided to a business by the government or another organisation to be used for a specific purpose. For example, it could be used to provide employment in a deprived area or invest in the research and development of an environmentally friendly alternative to fossil fuels.
Grants Advantages: Does not need to be paid back. No loss of ownership or control.
Grants Disadvantages: Business needs to meet certain criteria. It is time-consuming to apply for grants and to complete the paperwork.
Donations: These are sums of money given voluntarily to a charity or social enterprise.
Donations Advantages: No need to repay and no interest charges. No loss of ownership or control.
Donations Disadvantages: Likely to be small amounts only. Unpredictable.
Peer to Peer Lending: This involves one business person lending money to another business person in return for interest payments.
Peer to Peer Lending Advantages: Interest rates can be lower than lending from more traditional financial institutions. Fixed-rate of interest can be agreed upon to make it easier to plan and budget.
Peer to Peer Lending Disadvantages: Amounts available may be limited and provided for a short period of time only.
Invoice Discounting: These are reductions offered to customers making a product or service cheaper, often applied as a percentage.
Invoice Discounting Advantages: No need to repay and no interest charges. No loss of ownership or control. Reduces costs to the business so increases profit.
Invoice Discounting: Often only available if purchases are paid in cash flow.
Internal Sources of Finance
Retained Profit: Is the amount of a business’s net income that is kept within its accounts, rather than paid out to shareholders.
Retained Profit Advantages: No interest charges. Available immediately. Only available up to the amount already accumulated by the business and therefore avoids debt. No loss of ownership (control).
Retained Profit Disadvantages: This is the amount available may be limited. Reduces payments to shareholders which may cause dissatisfaction. Once used it is not available for alternative purposes.
Net Current Assets: Net current assets is the aggregate amount of all current assets, minus the aggregate amount of all current liabilities.
Net Current Asset Advantages: Encourages the business to manage cash flow effectively.
Net Current Disadvantages: Can put pressure on customers as shorter credit terms are offered and this negatively affects relationships with suppliers if longer credit terms are negotiated. Lower stock holdings can affect the firm's ability to meet customer needs.
Sale of Assets: This is when a business sells items that they no longer need for example machinery or transport. They can then use this money to re-invest into other areas of the business.
Sale of Assets Advantages: No interest charges. Reduces capital tied up in assets, releasing it for other purposes. Can mean disposing of an assets no longer of use to the business.
Sale of Assets Disadvantages: It is likely that the amount received is not a true reflection of the value of the asset. Can increase costs in the long term if an asset needs to be leased back.