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N C IN G

S F IN A
S IN ES
BU
You w illlearn ...

Why businesses need finance

The different sources available

How managers choose between the


different sources
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s need
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Why
nc e?
fina
Why Do Businesses
Need Finance?
To start up the business
To expand the business
To deal with difficulties
facing the business
Capital Expenditure
Revenue Expenditure
Types ofExpenditure

Capital Expenditure Revenue Expenditure

Money spent on Fixed Money spent on day-to-


Assets day expenses
more than one year
Types ofExpenditure

Revenue Capital
Item
Expenditure Expenditure

Purchase of Building

Water Rates
Staff Wages
Office Computer

Gym Equipment

Maintenance of
Equipment
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siness
s of bu
Sourc e
a nc e
fn
Internal Sources of
Finance
Retained Sale of
Profits Surplus
Assets

Internal Sources of
Finance

Selling Owners
Inventories Savings
Internal Sources of
Finance
Retained proft (ploughed back
profit)
Profit kept in the business after the
owners have taken their share of the
profits.
Advantage
No repayment
Disadvantage
New Businesses
Profits too low to expand
Internal Sources of
Finance
Sale of Business Assets
Could be those that are no longer used
or outdated.
Advantage
Better use of capital
Disadvantage
Time Consuming
Not available to
small business
Internal Sources of
Finance
Sale of inventories
Used to raise cash
Advantages
Reduced Opportunity Cost
Save on Storage Costs
Disadvantage
Stock Shortages
Disappointed Customers
Internal Sources of
Finance
Owners savings
Put more of their savings into the
business
Advantages
Available Quickly
No Interest Payments
Disadvantage
Low Savings
Increased Risk
External Sources of
Finance
Issue of Bank Loan Debentures
Shares

External Sources of
Finance

Debt Grants &


Factoring Subsidies
External Sources of
Fi nanceof shares
Issue
PLC s only
Money obtained from
individuals or institutions
outside the business
Advantages
Permanent Source of Capital
No Interest Payments
Disadvantages
Dividends
External Sources of
FinanceLoan
Bank

Advantages
Quick to organize
Varied lengths of time
Low Interest Rates Large
Companies
Borrow Large Sums
Disadvantages
Repaid with Interest
External Sources of
Finance
Debenture
L-T Certifi cates issued by
limited companies
Advantages
Raise very L-T finance
Disadvantage
Creditworthiness &
reputation essential
Repaid
Interest
External Sources of
Finance
Factoring Debts
Debt factors are specialist
agencies that buy debts
of fi rms for immediate
cash
They may off er 90% of the
existing debt.
The debtor will then pay
the factor and the 10%
represents as the factors
External Sources of
Finance
Factoring Debts
Goods delivered & invoiced for
$100

ly 5
te 7
ia s $
ed e
m giv
im C

Co client customer
F
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py up
s th
to of lo w
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i
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e
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MFC
External Sources of
Finance
Factoring Debts

Advantages
Immediate Cash Available
Risk of Collecting Debt > Factor
Disadvantages
Firm does not receive 100%value of
debt
External Sources of
Finance & Subsidies by
Grants
Outside Agencies
E.g. Government
Advantages
Repaying usually not required
Disadvantages
Strings Attached
E.g. relocation
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Finance
iods of
Per
Periods of Finance
Overdrafts Debt Trade
Factoring Creditors

Short-Term

Period of Finance is
required for
Medium- Long-Term
Term
Hire Sale
Leasing Purcha Loan Loans Debentur
of
s es
se Share
New s Rights
Periods of Finance

Short-Term (S-T)
< 3 years
Medium-Term (M-T)
3 yrs to 10yrs
Long-Term (L-T)
> 10 years
S-T Finance -
Overdrafts
S-T Finance
Overdraft
Arranged by bank
Advantages
Spend more money than available in
bank account
Can be used for wages, paying
suppliers etc
Flexible form of borrowing
Disadvantages
Interest rates variable
Short time to repay
S-T Finance
Trade Credit
Businesses delay paying its
suppliers
Leaves business in better cash
position Customer buys
supplies from
manufacturer

Time period to pay


for supplies bought customer
manufactur
er
S-T Finance

Trade Credit

Advantages
Almost Interest Free
Length of Time to Pay Debt
Disadvantages
Possible Refusal of Discounts
Refuse Goods Payment Slow
S-T Finance
Debt Factoring
Goods delivered & invoiced for
$100

ly 5
te 7
ia s $
ed e
m giv
im C

Co client customer
F
M

py up
s th
to of lo w
w
i
M M inv l
fo nt er
ba FC FC o
ic e
FC ym tom s to
la pa e M a d
n nt
s e
nc y p cu S e C
e s y m F
pa M
MFC
Medium-Term Finance
Hire
Purchase

Own the
Payments Equipment

Return
Payments Equipment
Option to Buy

Leasing
Medium-Term Finance
Hire Purchase
Purchase fixed asset over longer
period of time
Advantages
No up-front Large Sum of Money
Needed for Asset
Disadvantages
Cash Deposit Needed at Beginning
Interest Rates High
Medium-Term Finance
Leasing
Allows firm to use the asset without
purchasing it
Can be purchased at end of leasing
period
Advantages
No up-front Large Sum of Money
Needed for Asset
Maintenance done by Leasing Company
Disadvantages
Total Cost Higher
Long-Term Finance
Issue of Shares - Equities Finance
Only available to limited companies
Public Limited Companies
Long-Term Finance
Issue of Shares - Equities Finance
Only available to limited companies
Public Limited Companies
Very Large Sums
New Expensive to
Organize &
Issues Advertise
Raise Additional
Rights Capital
Existing
Issues Shareholders
Long-Term Finance
Issue of Shares - Equities
Finance

Advantages
Permanent Capital
No Repayments
No Interest
Disadvantages
Dividends Paid After Tax
Balance of Ownership
Medium-Term Finance

Bank Loan

Advantages
Disadvantages
Long-Term Finance

Interest paid
Interest paid every year,
before tax dividends do not

L-T Loans
Debt Finance

Must be repaid

Not Permanent Secured against


Capital Collateral
Long-Term Finance

Debentures
(Same as External Finance )

Advantages
Long-term loan certificates
Often no collateral needed
Disadvantages
Creditworthiness & reputation essential
Repaid with Interest
Exercise
Source of Short-Term Medium-Term Long-Term
Finance (S-T) (M-T) (L-T)

Overdraft

Debentures
Issue of Shares

3-yr Bank Loan
Trade Credit
Hire Purchase
Exercise

Need for Most Suitable Reason for


Finance Source Choice
Planned take-over of
another business

Temporary increase
in stocks over
summer
Purchase of new car
for the CEO

R & D of new product


Launch in market in
4 yrs
Cost of Factory
Less land than at
present
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rce of
ht Sou
the rig
os in g
Cho
a nc e
Fin
Time Amount
Purpose Status
Period Needed

Choosing the right


Source of Finance

Size Control Risk Gearing


Risk is the danger that
Risk
failure or loss will occur.

Choosing the right


Source of Finance

Gearing is a measure of
risk. The proportion of
Gearing total capital raised from L-
T loans.
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olders
shareh
nd and
n ks le
W ill b a
es t ?
inv
Stability of
finance Cash-Flow
Future Business
records and Forecast
Plans
information

Reason for the Gearing


Profit & Loss
loan

Will banks lend you the money?


Will shareholders invest?

Future
Financial Share price
Business
Information variation
Plans

Dividend Gearing
Profit & Loss
Rate
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invest?
holders
e share
Will th
Will shareholders invest?

Compare Dividend Rates

Compare Future Company


Prospects

Share Price Variation

Gearing ratio
Business Plans

Business Plans
Business Objectives
force owners to
think ahead and
Important Details
plan carefully for
Operations first the few years
Finances
Business Plans
Considerations
Can we break-even
or make a proft?
Where will the firm
What to make?
be located?
products
What machinery
What consumers
will the firm need?
are we aiming at?
How many staf
What will be the
does the firm need?
main costs?
How many
products to make?
Pizza Place Ltd Business Plan
Pizza Place Ltd Business Plan
QUICK QUIZ!

What can you use an overdraft for?


How long is a source of finance
needed to be considered medium
term?
Name one thing the bank manager
needs to get from you before
granting a large loan?
What is the difference between rights
issue and new issues of share?
M O RE
Which of these are short, medium, or long term
sources of finance?

Overdraft
5 year loan
Issue of shares
Debenture
Trade credit
Hire purchase
Which of these are internal or
external sources of finance?
Bank loan
Retained profit
Owners saving
Governmental grants
Sale of unused asset