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3.1 sources of finance

the role of finance

all businesses need money to finance various activities

they can use sources from internal or external

there are various factors they need to consider when selecting sources

availability

cost of finance (usually from interest charges)

time period of repayment

capital or revenue expenditure

capital expenditure is finance spent on fixed assets

items used repedetedly in the long term to generate sales revenue

(equipment, machinery, vehicles, buildings)

revenue expenditure

is the finance spent on the daily running of the business (wages, rent,
utilities, raw materials)

internal sources

come from within the business (usually short term)

personal funds

main source for sole traders and partnerships

retained profits

the value of profits that the business keeps to use within the business (after paying
taxes and dividends)

short-medium term

3.1 sources of finance 1

 sale of assets

businesses can sell assets

sale of fixed assets (divestment)

sale of dormant (unused) assets

external sources
come from outside the business

share capital

money raised from selling shares in the company (main source for most limited
liability companies)

private limited companies cannot sell their shares to the general public; public
limited companies can through IPO

(+) can raise huge amount of finance (-) time consuming, expensive IPO,
no guarantee of interest of investors

loan capital

medium/long term sources obtained from commercial lenders such as banks (there is
interest and repaid in instalments)

mortgage, business development loan, debentures

(+) repayment by instalments gives time to earn revenue (-) depending on

interest rate cost may be high, if collateral is provided and business fails the
lender takes possesion of the asset

debentures

long term loans through a certificate that certifies an amount of money owed to
someone - debenture holders gets paid in any case

debenture holders receive interest payments (individuals, governments, other

businesses)

(+) secured investments (-) high interest rates

overdrafts

allows the business to temporarily overdraw on its bank account (to take out more
money than it has in its account)

commonly used when businesses have minor cash problems

3.1 sources of finance 2

 (+) flexible finance (-) cost of borrowing is high due to the high interest
rates

trade credits

allows a business to 'buy now and pay later'

offer trade credit: creditors, customers: debtors (moslty used in supply chain)

(+) allows time for businesses to process (-) payment on invoices are late
(charged overdue payment penalties)

grants

the government may over financial gifts

financial aid-non-repayable but to be used for defined purposes

(+) do not need to be repaid (-) only available in regions the government is
interested in, time consuming and no guarantee

subsidies

special assistance that governments provide businesses to offset operating cost over
a lengthy time period

help companies reduce their costs of production (purpose: provide extended

benefits to society)

(+) shortfalls in profit are made up by subsidies (-) only available in regoins the
government is interested in, time consuming and no guarantee

debt factoring

the sale of a business' invoices to a third party: is charged with processing the
invoice

financial service that allows a business to raise funds based on the value owned
by its debtors

(+) no risk of the debt (-) reduces overall profits

leasing

the lessee (customer) pays rental income to hire assets from the lessor (legal owner
of the assets)

sale-and-leaseback involves selling a particular fixed asset (to raise finance)

and immediately leasing the property back (the business transfers ownership
although the asset does not physically leave the business)

3.1 sources of finance 3

 (+) taxes are reduced alligned with the profits, cheaper , repairs and
maintenant is on lessor (-) in the long run, cost of leasing can be more than
purchasing

venture capital

form of high-risk capital, form of loans and shares invested by venture capital firms
or individuals

criteria for investing: return on investment, business plan, people, track record

(+) source of funding for firms that are unable to secure loands from banks
(-) loss of control, high risk of failure, may have to buy out the stake with
great expense

business angels

extremely wealthy individuals who choose to invest their own money in businesses
that offer high growth potential

they tend to take a proactive role in the setting up/runniing of the business
venture

(+) funding for firms unable to secure loans from banks (-) loss of control,
may have to buy out the stake , high risk

for the financial managers:

cash flow position

amount of the money needed

repayment methods (time frame)

short term (1 year)

medium term (more than 1, less than 5 years)

long term (more than 5 years)

time frame

short term medium term long term

internal s.

personal funds ✔
retained profits ✔ ✔ ✔
sale of assets ✔

3.1 sources of finance 4

 external s.

business angels ✔ ✔ ✔
debentures ✔
debt factoring ✔
grants ✔ ✔ ✔
subsidies ✔ ✔ ✔
leasing ✔ ✔ ✔
loan capital ✔ ✔
overdrafts ✔
share capital ✔
trade credit ✔
venture capital ✔ ✔

3.1 sources of finance 5