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Business Finance: Needs and Sources - Coggle Diagram
Business Finance: Needs and Sources
Why businesses need finance
Additional working capital
capital expenditure
lasts for more than a year
money spent on non current assets
buildings
working capital
majority of trading halts because of a shortage of working capital
the "life blood" of a business
finance needed by a business to pay day to day costs
revenue expenditure
money spent on day to day expenses
wages
rent
Capital for expansion
another business could be taken over
additional non current assets could be purchased
more machinery
larger buildings
expansion for increased profits
development of new products to reach more markets
would require a lot of finance for research and development
Start up capital
needed to launch a new business
the finance needed by a new business to pay for essential non current and current assets before it can begin trading
Short and Long Term Finances
Short Term
provides the business with working capital for day to day operations
Overdrafts
arranged by banks
advantages
allows the business to overdraw the bank account
can use to pay wages or suppliers, but not indefinitely
overdraft will vary each month depending on the needs of the business; flexible form of borrowing
interest is paid only on the amount overdrawn
overdrafts can be cheaper than short term loans
disadvantages
interest rates are variable
bank can ask for overdraft repayment on short notice
Trade credit
where the business delays payments to the suppliers
advantages
it is an almost interest free loan for the amount of time it is delayed for
disadvantages
the supplier might stop giving discounts or supply if payments are too delayed
Factoring of debts
debtors are people who owes a business money for goods bought
debt factors "buy" the claims of debtors of a business for immediate cash
advantages
immediate cash is made available to the business
risk of debt collection is delegated to another business
disadvantages
business doesn't receive the whole value of the debt
Long Term
finance available for more than a year
used to...
purchase long term fixed assets
update or expand the business
finance a takeover of another business
Bank Loans
payable over a fixed period of time
advantages
quick to arrange
can last for varying lengths of time
often offered low rates of interest if large sums are borrowed
disadvantages
bank loans must be repaid, and so must interest
security or collateral is usually required
Hire Purchase
allows business to buy non current asset over monthly payments
advantages
no need to expend a large sum of money to purchase
disadvantages
cash deposit is made in the beginning
interest payments can be high
Leasing
allows business to use asset without needing to purchase it
monthly leasing payments are made
advantages
business does not have to find a large cash sum to purchase
care and maintenance of the asset goes to the leasing company
some business sell the non current assets for cash and lease then back from a leasing company
disadvantages
total cost of leasing will be higher than just purchasing
Issues of shares
only available to limited companies
public limited companies can sell shares to the general public
this can raise a lot of finance from the shareholders
advantages
limited liability to the shareholders
separate legal identity from shareholders
raise very large sums of capital
no restriction of buying, selling or transferring shares
usually has high status
disadvantages
complicated legal formalities
more regulations and controls to protect shareholders
selling shares to the public are expensive
chances of losing control of the business if it goes public
Debentures
long term loan certificates issued by limited companies
advantages
can be used to raise very long term finance
disadvantages
as with loans, must be repaid with interest
Internal and External Finances
Internal Finance
Retained Profit
profit kept in the business after owners take their share
advantages
does not need to be repaid
no interest
disadvantages
a new business does not have retained profits
small firms' profits may not be enough to fund expansion
keeping more payments within the business reduces payments to the owners
examples
cost of goods sold
depreciation
sales revenue
Sale of Existing Assets
existing assets that are sold when redundant
advantages
makes better use of capital tied in the business
does not increase business debts
disadvantages
may take time to sell assets
worth of assets are unknown until sold
unavailable for new businesses
examples
redundant buildings
surplus equipment
Sale of Inventories to Reduce Inventory Levels
advantages
reduces opportunity cost and storage cost of high inventory levels
disadvantages
must be done carefully to avoid disappointing customers if not enough goods are kept as inventory
examples
the sale of apples when there's an excess of such
the sale of wood when there is too much in a warehouse
Owner's Savings
a sole trader or members of a partnership can put their savings into the business
advantages
quickly available firm
no interest is paid
sole traders or partnerships do not have a separate legal identity from the owner
examples
savings from their previous incomes
selling old valuables to raise capital
disadvantages
savings may be too low
increases risk taken by the owners because of unlimited liability
External Finance
Issues of shares
only available to limited companies
public limited companies can sell shares to the general public
this can raise a lot of finance from the shareholders
advantages
limited liability to the shareholders
separate legal identity from shareholders
raise very large sums of capital
no restriction of buying, selling or transferring shares
usually has high status
disadvantages
complicated legal formalities
more regulations and controls to protect shareholders
selling shares to the public are expensive
chances of losing control of the business if it goes public
examples
shareholders
Bank Loans
payable over a fixed period of time
advantages
quick to arrange
can last for varying lengths of time
often offered low rates of interest if large sums are borrowed
disadvantages
bank loans must be repaid, and so must interest
security or collateral is usually required
examples
bank loans
Selling Debentures
long term loan certificates issued by limited companies
advantages
can be used to raise very long term finance
disadvantages
as with loans, must be repaid with interest
examples
treasury bonds
treasury bills
Factoring of debts
debtors are people who owes a business money for goods bought
debt factors "buy" the claims of debtors of a business for immediate cash
advantages
immediate cash is made available to the business
risk of debt collection is delegated to another business
disadvantages
business doesn't receive the whole value of the debt
examples
debt factoring companies
Grants and Subsidies from Outside Agencies
examples
the government
advantages
grants and subsidies do not need to be repaid
disadvantages
often given to influence the firm to do something
Micro finance
in low income developing countries where traditional commercial banks don't lend loans to poor people
causes
size of loans are usually too small to make a profit from
poorer people usually don't have assets to use as "security"
examples
postal savings banks
finance cooperatives
credit unions
development banks
Crowdfunding
encouraging large numbers of people to invest small amounts for a start up business
became more popular with the spread of the internet
examples
Kickstarter
Rocket Hub
FundAnything
advantages
no initial fees payable to the platform
fees only apply if the finance required is raised
can gage the public's reaction to the venture
can be fast in order to raise large sums of money
often used by entrepreneurs when traditional methods don't work
disadvantages
platforms may reject the proposal if it is not well thought out
if the amount required is not raised, the finance will be repaid
media interest and publicity needed in order to increase chances of success
publicising the idea might make it vulnerable to stealing, allowing competitors to create the product first
How Businesses Make The Choice
Purpose and Time Period
what would the finance be used for?
general rule
long term solutions for long term problems
short term solutions for short term
there are disadvantages that may come with each source
Amount Needed
different sources would be required depending on the amount of money needed
Legal Form and Size
some companies may have more choice compared to others
a public limited company might have high chances to gain funds from a bank rather than a sole trader
smaller firms and sole trader business are at an disadvantage
these smaller firms would often use personal capital
Control
owners of a business might lose control if too many people are asked to finance or invest in the firm
owners may have to decide between...
expanding the business
keeping control of the business
Risk and Gearing
loan capitals would increase the gearing of the business
gearing a business measures the proportion of total capital raised from the long term loans
the business would be at risk if it is highly geared, which makes entrepreneurs reluctant to use risky methods
a highly geared business is one with a very high proportion of debt and capital