Sources of Finance


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Sources of Finance

  1. 1. Sources of Finance tutor2u ™ GCSE Business Studies Revision Presentations 2004
  2. 2. Reasons a Business Needs Finance <ul><li>Start a business </li></ul><ul><li>Finance new technology </li></ul><ul><li>Open new markets </li></ul><ul><li>Acquisitions </li></ul><ul><li>Moving to new premises </li></ul><ul><li>Day to day running of business </li></ul>
  3. 3. Internal and External Sources <ul><li>Internal Sources of Finance </li></ul><ul><ul><li>Come from trading of business </li></ul></ul><ul><ul><li>Day to day cash from sales to customers </li></ul></ul><ul><ul><li>Money loaned from trade suppliers through extended credit </li></ul></ul><ul><ul><li>Reductions in amount of stock held by business </li></ul></ul><ul><ul><li>Disposal (sale) of any surplus assets no longer needed (e.g. selling a company car) </li></ul></ul><ul><li>External finance </li></ul><ul><ul><li>Comes from individuals or organisations who do not trade directly with business </li></ul></ul><ul><ul><li>E.g. banks, investors. government </li></ul></ul>
  4. 4. Short and Long-term Finance <ul><li>Short term finance </li></ul><ul><ul><li>Needed to cover day to day running of business </li></ul></ul><ul><ul><li>Paid back in a short period of time, so less risky for lenders </li></ul></ul><ul><li>Long term finance </li></ul><ul><ul><li>Tends to be spent on large projects which will pay back over a longer period of time </li></ul></ul><ul><ul><li>More risky so lenders tend to ask for some form of insurance or security if company is unable to repay loan. </li></ul></ul><ul><ul><li>A mortgage is an example of secured long-term finance </li></ul></ul>
  5. 5. Main Sources of Long-term Finance <ul><li>Mortgages </li></ul><ul><li>Bank loans </li></ul><ul><li>Share issues </li></ul><ul><li>Debentures </li></ul>
  6. 6. Criteria for Choosing a Source of Finance <ul><li>Amount of money required </li></ul><ul><li>How quickly money is needed </li></ul><ul><li>Cheapest option available </li></ul><ul><li>Amount of risk involved in reason for cash </li></ul>
  7. 7. Using Own Cash to Start a Business <ul><li>Own cash is cheapest form of finance since it carries no obligation to pay any interest </li></ul><ul><li>Don’t need to give any control of business to any other party </li></ul><ul><li>More flexible than other sources </li></ul><ul><ul><li>No authorisation “hurdles” to overcome </li></ul></ul><ul><ul><li>Can add more finance if required (and available) </li></ul></ul><ul><ul><li>Various tax incentives for people who invest in their own business </li></ul></ul>
  8. 8. Sources of Finance for Sole Traders and Partnerships <ul><li>Bank loans </li></ul><ul><li>Bank overdraft </li></ul><ul><li>Trade credit </li></ul><ul><li>Retained profits </li></ul><ul><li>Taking on a new partner </li></ul><ul><li>Government grants (depending on area and activities </li></ul><ul><li>Remember – there is no company; so a sole trader or partnership cannot have shareholders providing finance </li></ul>
  9. 9. Share Issues <ul><li>Two types of limited company that define the way that money can be raised through shares. </li></ul><ul><ul><li>A private limited company can sell shares only to designated people and there is a limit how much capital they can raise through this method </li></ul></ul><ul><ul><li>A public limited company can issue shares to the public. This means anyone can have a share in the company </li></ul></ul><ul><li>Finance raised by a company by selling new shares to shareholders </li></ul><ul><li>Unlike a loan money does not have to be repaid over a fixed period of time </li></ul><ul><li>Note: when one shareholder sells shares to another, the company does not raise any additional funds – since no new shares have been issued </li></ul>
  10. 10. Ordinary Shares and Preference Shares <ul><li>Ordinary shares </li></ul><ul><ul><li>The most common form of share capital </li></ul></ul><ul><ul><li>Ordinary shareholders can vote at company meetings </li></ul></ul><ul><ul><li>Amount of dividend received varies </li></ul></ul><ul><li>Preference shares </li></ul><ul><ul><li>Shareholders do not have a vote at company meetings </li></ul></ul><ul><ul><li>Dividend is usually fixed (e.g. 5% of value of shares held paid as dividend each year) </li></ul></ul><ul><ul><li>Shareholders receive their dividend before ordinary shareholders </li></ul></ul>
  11. 11. Return on Investment for Ordinary Shareholders <ul><li>Comes in two parts: </li></ul><ul><ul><li>Dividends - paid out on each share held by company </li></ul></ul><ul><ul><li>Increases in value of each share as company itself grows in value (“capital gain”) </li></ul></ul><ul><li>Note 1: a shareholder only actually “realises” a gain on the increased value of a shareholding when those shares are sold. Otherwise it is just a gain “on paper” </li></ul><ul><li>Note 2: Companies do not have to pay out dividends </li></ul><ul><ul><li>There may be no profit available (dividends can only be paid out of profits) </li></ul></ul><ul><ul><li>The shareholders may wish to reinvest profits in the business rather than take cash out </li></ul></ul>
  12. 12. Debentures <ul><li>Source of long term finance </li></ul><ul><li>In the form of a loan </li></ul><ul><li>Usually secured against an asset </li></ul><ul><li>Repayable at a fixed date </li></ul><ul><li>Fixed rate of interest </li></ul>
  13. 13. Difference between Debentures and Ordinary Shares <ul><li>Lender has no voting rights in company </li></ul><ul><li>Loan attracts interests – whereas holders of ordinary shares get dividends </li></ul><ul><li>Providers of loans are paid out before ordinary shareholders in event that business fails (assuming there is some cash left) </li></ul>
  14. 14. Finance Available from a Bank <ul><li>Bank overdraft </li></ul><ul><li>Bank loans </li></ul><ul><li>Asset finance (leasing) </li></ul>
  15. 15. Bank Overdrafts and Bank Loans <ul><li>Bank overdraft </li></ul><ul><ul><li>Limit on borrowing on a bank current account </li></ul></ul><ul><ul><li>Amount of borrowing may vary on a daily basis </li></ul></ul><ul><ul><li>Technically repayable on demand by the bank </li></ul></ul><ul><li>Bank loan </li></ul><ul><ul><li>Fixed amount for a fixed term </li></ul></ul><ul><ul><li>Regular fixed repayments </li></ul></ul><ul><ul><li>Interest on a loan tends to be lower than an overdraft </li></ul></ul><ul><ul><li>Normally a fixed term loan will be for a greater amount than an overdraft </li></ul></ul>
  16. 16. Working Capital <ul><li>Amount of short term capital available for day to day running of business </li></ul><ul><li>Expressed as current assets less current liabilities e.g. value of debtors and stocks less creditors </li></ul><ul><li>Working capital normally needs to be funded </li></ul><ul><ul><li>E.g. the value of stocks and trade debtors is more than the value of trade creditors </li></ul></ul>
  17. 17. Debt Factoring <ul><li>Business sells its outstanding customer accounts (those who have not paid their debts to business) to a debt factoring company </li></ul><ul><li>Factoring company pays business face value of debts less a charge (e.g. 15-20%), but then collects full amount of debts for itself </li></ul><ul><li>Good way of raising cash quickly, without hassle of chasing payments </li></ul><ul><li>BUT not so good for profits since it reduces total revenue received from those sales </li></ul>
  18. 18. Government Grant Funding <ul><li>Protect jobs in failing/declining industries </li></ul><ul><li>Help create jobs in areas of high unemployment </li></ul><ul><li>Help start up new businesses </li></ul><ul><li>Help businesses relocate to areas of high unemployment </li></ul><ul><li>Examples </li></ul><ul><ul><li>European Structural Fund </li></ul></ul><ul><ul><li>Assisted Areas </li></ul></ul><ul><ul><li>Regional Selective Assistance </li></ul></ul>
  19. 19. Leasing <ul><li>What is involves </li></ul><ul><ul><li>Like renting a piece of machinery/equipment </li></ul></ul><ul><ul><li>Business pays a regular amount for a period of time </li></ul></ul><ul><ul><li>Items belong to leasing company </li></ul></ul><ul><li>Advantages </li></ul><ul><ul><li>Cheaper in short run than buying a piece of equipment outright </li></ul></ul><ul><ul><li>If technology is changing quickly or equipment wears out quickly it can be regularly updated or replaced </li></ul></ul><ul><ul><li>Cash flow management easier because of regular payments </li></ul></ul><ul><li>Disadvantages </li></ul><ul><ul><li>More expensive in long run, because leasing company charges fees which make total cost greater than original cost </li></ul></ul>
  20. 20. Hire Purchase <ul><li>Business hires equipment for a period of time making fixed regular payments </li></ul><ul><li>Once payments have finished it then owns piece of equipment </li></ul><ul><li>Different to leasing in that business owns equipment when it has finished making payments </li></ul>
  21. 21. Sources of Finance for Public Sector Businesses <ul><li>Tax revenue from government, usually paid out in form of grants or subsidies </li></ul><ul><li>Fees paid by public or businesses e.g. trading licences </li></ul><ul><li>E.g. In case of BBC, money from TV licence </li></ul>