Chapter 16 - Sources of finance
Business ownership and sources of finance
The sources of finance available to a business can be influenced by the legal structure of an individual business, size of the business, reason for finance, amount of finance needed, length of time needed for
A sole trader or partnership wouldn't have access to share capital unless they changed the structure of their business to a private limited company or a public limited company
Sale of shares in a private limited company is limited, cant be sold to the public
A public limited company is able to sell shares to anyone through the stock exchange
Internal sources of finance
Internal sources of finance are those sources within the business itself
Retained profit (Profit earned by the business in its previous year of trading)
Advantages
Doesn't require interest payments to be made
Doesn't have to be repaid
Instantly available
Doesn't create debt
Disadvantages
It is dependant on previous years having been profitable
If shareholders prefer larger dividends they might not agree to its use
Sale of unwanted assets (Asses that are no longer used turned into cash)
Advantages
Finance doens't have to be repaid to anyone
Doesn't incur interest payments
Fast method of obtaining finance
Disadvantage
Amount raised might not be large
Assets and use are permanently lost to the business
Sale and leaseback of non-current assets
Advantages
Quick source of funds
Doesn't require repayment
Doesn't incur interest payments
Disadvantages
Needs to have regular payments
Not a large amount raised
Internal sources might be insufficient to satisfy financial needs of the business
External sources of finance
Includes overdrafts and short term bank loans, introduction of new partners, sale of shares
Short term sources of finance
Bank overdradt
Working capital
Advantages
Permanant source of finance
Old inventory easily sold off
Fast way to raise finance
Disadvantages
Current assets might be reduced
Customers unsatisfied
Advantages
Quick to put in place
No loss of ownership or control
Flexible
Disadvantages
Expensive due to high interest rates
Overdrafts recalled at short notice
Business needs evidence that it will receive funds shortly
Long term sources of finance
Introduce new partners
Advantages
Disadvantages
Quick
Permanant
Ownership and control lost
Sole trader takes on losses
Share capital
Advantages
Permanent source of finance
Potentially raises large sums of money
Disadvantages
Ownership is diluted if new owners introduced
Authorised share capital will limit share selling
Leasing
Advantages
No large expenditure needed
Repairs and maintenance undertaken by person who owns asset
Disadvantages
Requires ongoing regular payments
Business never owns asset
Hire purchase
Advantages
Asset paid for over agreed time period
Regular payments made
Disadvantages
Lack of ownership until all payments made
Interest paid on asset
Mortgages
Advantages
Disadvantages
Large amounts raised
Ownership remains unaffected
Value of asset falls below value of original loan, value is still due
Asset sold but debt must be cleared
Interest payment determined by current rate of interest of fixed term
Debentures
Advantages
Ownership and control unaffected
Large amount of finance raised
Disadvantages
Fixed rate must be paid, whether or not the business is profitable
Debenture linked to a specified asset that can be sold if there is a lack of repayment
Venture capital
Advantages
Disadvantages
Business advice is frequently available as well as finance
Loan might be a permeant source of finance
Loss of control and ownership
Future profits shared with lender
Government grants and loans
Advantages
Disadvantages
Permenant finance
Doesn't have to be repaid
Strict guidelines
Relocation required
Microfinance
Advantages
Money made available to people without credit history
Benefits small business in self-sufficient areas
Disadvantages
Amounts are small
Interest has to be paid
Crowdfunding
Advantages
Large amounts can be raised
Used by people with a good business idea but a lack of finance
Disadvantage
Accountability to more people
Investors expect discounts
Factors affecting sources of finance and the selection of sources of finance
Different sources of finance are appropriate in different circumstances
The financial history of the business: Includes the length of time that has been in existence, and the evidence that shows how well or not its financial affairs have been managed
Whether the finance is required for the short term or long term: A short term need for finance would be advisable to pay suppliers and wages until customers settle their debt
The use to which the finance will be put: large projects are financed by long term sources because it will be a long time until profits are gained
The need to retain control: ownership and control of a business must also be considered. owners might prefer to choose a source of finance that doesn't dilute ownership
Cost of various options: rate of interest to be paid, some sources, fixed interest loans are available
Debentures: incur lower payments initially as interest is paid until the maturity date
Flexibility: a bank loan is more flexible in the ways that you can use the money, also required in payment amounts