Sources+of+Finance

SOURCES OF FINANCE/FUNDS

We can distinguish between internal and external sources of finance. Internal sources come from within the business-eg owners or shareholders. External comes from banks and other organizations We also can distinguish between short term sources of funds (repayable within the year) medium term sources (repayable within 2-8 yrs) and Long term sources.


 * Owner's Capital - As you probably know, this is often the only source of capital available for the sole trader starting in business. The same often applies with partnerships, but in this case there are more people involved, so there should be more capital available. Tends to be used for setting up the business, purchasing capital equipment etc. Would owners be happy every time the business is a bit short of cash, to be asked for more finance? (Long term internal source)


 * Shareholders' Capital - Shareholders are of course the owners of a Limited Company, they invest money in the hope of capital growth, (that is the business makes profits, grows, makes more profits, so as the business becomes bigger their investment will be worth more), and dividend (the shareholders share of the companies profits). It is quite normal for limited companies to issue new shares if they want to expand or purchase a new company. (Long term internal source)


 * Retained Profit - At the end of the trading year a business will work out its profit. All of this profit can be taken by the owners, (this would be a dividend in limited company), or alternatively some or all of it could be reinvested in the company, to help the business grow and therefore make even more profit in the future. (Long term internal source)


 * Overdraft - This is a form of loan from a bank. A business becomes overdrawn when it withdraws more money out of its account than there is in it, this leaves a negative balance on the account. This is often a cheap way of borrowing money as once an overdraft has been agreed with the bank the business can use as much as it needs at any time, up to the agreed overdraft limit. But, the bank will of course, charge interest on the amount overdrawn, and will only allow an overdraft if they believe the business is credit worthy i.e. is very likely to pay the money back. A bank can demand the repayment of an overdraft at any time. Many businesses have been forced to cease trading because of the withdrawal of overdraft facilities by a bank. Even so for short term borrowing, an overdraft is often the ideal solution, and many businesses often have a rolling (on going) overdraft agreement with the bank. This then is often the ideal solution for overcoming short term cash flow problems, e.g. funding purchase of raw materials, whilst waiting payment on goods produced. (short term external source)


 * Bank Loan - This is lending by a bank to a business. A fixed amount is lent e.g. £10,000 for a fixed period of time, e.g. 3 years. The bank will charge interest on this, and the interest plus part of the capital, (the amount borrowed), will have to be paid back each month. Again the bank will only lend if the business is credit worthy and it may require security. If security is required, this means the loan is secured against an asset of the borrower, e.g. his House if a Sole Trader, or an asset of the business. If the loan is not repaid, then the bank can take possession of the asset and sell the asset to get its money back! Loans are normally made for capital investment, so they are unlikely to be used to solve short-term cash flow problems. But if a loan is obtained, then this frees up other capital held by the business, which can then be used for other purposes. (Medium or long term external)


 * Leasing - With leasing a business has the use of an asset, but pays a monthly fee for its use and will never own it. Think, of, someone setting up business as a Parcel Delivery Service, he could lease the van he needs from a leasing company. He will have to pay a monthly leasing fee, say £250, which is very useful if he does not wish to spend £8,000 on buying a van. This will free up capital, which can now be used for other purposes. A business looking to purchase equipment may decide to lease if it wishes to improve its immediate cash flow. In the example above, if the van had been purchased, the flow of cash out of the business would have been £8,000, but by leasing the flow out of the business over the first year would be £3,000, leaving a possible £5,000 for other assets and investment in the business. Leasing also allows equipment to be updated on a regular basis, but it does cost more than outright purchase in the long run. (medium term external)


 * Hire Purchase - This is similar to leasing, but at the end of the hire period the asset belongs to the company that hires it. (medium term external)


 * Selling Assets - A business can sell assets it owns to raise capital! This is often a last gasp measure as assets are usually vitally necessary to business activity. In some cases the business may lease back the asset, so that it still retains its use. But this often the preserve of big business e.g. the sale and lease back of office blocks. Selling assets, and leasing the asset back improves cash flow in the short term. If the cash raised from the sale of the asset is used effectively by the business, cash flow and profitability can also increase in the long term. (internal)


 * Debtors - If a firm is in immediate need of cash it could chase its debtors for repayment. This may involve giving discounts for early repayment. Chasing debtors for early repayment may lead to long term loss of trade, as the debtors may buy from another business next time, but it can be an effective method of solving short-term cash flow problems. (short term )


 * Factoring - For larger firms, with a turnover (sales) of £100,000 or more a year, it is possible to let a Factor manage your debts for you. The factor (a type of finance company) will pay 80% of the value of an invoice at the time of sale, and will take responsibility for receiving payment from the debtor. The balance of the debt will be passed on when the money is received by the factor. There is of course a charge for this. (short term)


 * Trade Credit-purchasing goods on credit.


 * Government agencies and charities and NGOs


 *  Venture Capital firms

**Student Activity:**

Using the examples above categorise the sources of finance into internal and external sources of finance? Using the examples above categorise the sources of finance into short and long term sources of finance? Complete the following table by reading Chapters 25-26


 * Source ||  Advantage ||  Disadvantage ||
 * Retained profit ||  ||   ||
 * Sale of Assets ||  ||   ||
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Reducing Stocks ||  ||   ||
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Owners savings/capital ||  ||   ||
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Shareholders capital ||  ||   ||
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Loan ||  ||   ||
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Capital ||  ||   ||
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Grants ||  ||   ||
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Debentures (loan certificate-like shares but no ownership rights) ||  ||   ||
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Trade credit ||  ||   ||
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Overdraft ||  ||   ||
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Factoring ||  ||   ||
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Leasing/hire purchase ||  ||   ||

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