THE FROG’S EQUATION: BUSINESS STUDIES FOR IGCSE

Financing Business Activity

Why do businesses need finance?
 starting up a business
 expanding an existing business
 a business in difficulties
*businesses need finance to pay capital expenditure or revenue expenditure
Capital- money spent on fixed assets which will last for more than a year
Revenue- money spent on day-to-day expenses which do not involve the
purchase of a long term asset, e.g. wages

Sources of finance
Internal finance: money obtained from within the business itself
 retained profit
 retained profit does not have to be paid back
 a new business will not have any
 many small businesses find their profits too low to finance expansion
 keeping profits in business reduces payments to owners
 sale of existing assets
 makes better use of capital in business
 takes some time to sell assets
 not available for new businesses as they have no assets or surpluses
 running down stocks to raise cash
 reduces opportunity cost and storage cost
 must be done carefully to avoid disappointing customers
 owners savings
 should be available to the firm quickly
 no interest
 savings may be low
 increases risk taken by owners

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Paula Hohne-Tarragona
THE FROG’S EQUATION: BUSINESS STUDIES FOR IGCSE

External finance: money obtained from individuals or institutions outside the

business
 issue of shares
 permanent source of capital, does not have to be repaid
 no interest paid
 dividends expected by shareholders
 ownership could change hands
 bank loans
 varying lengths of time
 large companies offered low interest rates if they borrow large sums
 bank loan will have to be repaid and interest must be paid
 security or collateral is required
 selling debentures- long term loan certificates issued
 can be used to raise vary long term finance
 they must be repaid with interests
 factoring of debts- specialist agencies that ‘buy’ debts for cash
 immediate cash is available
 risk of collecting the debt becomes the factor’s
 firm doesn’t receive 100% of the values of debt
 grants and subsidies from outside agencies
 these usually do not have to be repaid
 they are given with ‘strings attached’ e.g. firm must locate in
particular area

Short term finance: for day-to-day operations

 overdrafts- arranged by the bank
 bank gives business right to overdraw its bank account
 the firm could use this to pay wages or suppliers, but not indefinitely
 varies each month with the needs of the business, flexible
 interest only on the overdrawn money
 interest rates are variable
 bank can ask for overdraft to be paid for at very short notice
 trade credit- when a business delays paying its suppliers
 almost interest free loan to the business
 supplier may refuse to give discounts or even to supply if payments
are not made quickly
 factoring of debts

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Paula Hohne-Tarragona
THE FROG’S EQUATION: BUSINESS STUDIES FOR IGCSE

Medium-term finance: finance which is available for between 3 and 10 years

 bank loans
 hire purchase- allows business to buy fixed asset over long period of time
 firm does not have to find a large sum of money
 cash deposit is paid at start of period
 interest payments can be quite high
 leasing- allows a firm to use an asset without purchasing it
 the firm doesn’t have to find large sums of money
 the care and maintenance of the asset are done by the leasing
company
 total cost of leasing charges are higher than purchasing the asset

Long-term finance: is available for more than 10 years

 issue of shares
 long term loans or debt finance
 debentures

Factors affecting method of finance

The choice of finance: the right type of finance has to be chosen
 purpose and time period
 amount needed
 statues and size
 control
 risk and gearing

Bank loans: banks may not always want to give a loan to a business
 Is cash forecast available?
 Is a business plan available?
 Is a forecasted profit and loss account available?
 Why is the loan needed?
 Will the loan be secured?
 What is the gearing ratio?

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Paula Hohne-Tarragona