N C IN G

S FIN A
S IN ES
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You will learn ...

 Why businesses need finance

 The different sources available

 How managers choose between the different

sources
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 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 of Expenditure

Capital Expenditure Revenue Expenditure

Money spent on Fixed Assets Money spent on day-to-day

more than one year expenses
Types of Expenditure

Item Revenue Expenditure Capital Expenditure

Purchase of Building

Water Rates

Staff Wages

Office Computer

Gym Equipment 
Maintenance of Equipment 

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Sou rce
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Internal Sources of
Finance
Retained Profits Sale of Surplus
Assets

Internal Sources of Finance

Selling Owners
Stocks Savings
 Internal Sources of
Finance
Retained profit (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or outdated.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
Running Down
Stocks
Used to raise cash
 Advantages
 Reduced Opportunity Cost
 Save on Storage Costs
 Disadvantage
 Stock Shortages
 Disappointed Customers
Internal Sources of
Finance
 Owner’s Money
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 Finance
 Issue of shares
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 Finance
 Bank Loan

 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 factor’s
External Sources of Finance
 Factoring Debts
Goods delivered & invoiced for $100

M mm
FC ed
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s $ ly
Co
client 75 customer
py up
of s
M invo l low with
FC ic C fo nt er e nt
e F e
to M aym tom aym
p cus s p FC
e nd to M
S
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
 Grants & Subsidies by
Outside Agencies
E.g. Government
 Advantages
 Repaying usually not required
 Disadvantages
 “Strings Attached”
 E.g. relocation
 d p i ct u re
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Finance
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Per
 Periods of Finance
Overdrafts Debt Factoring Trade Creditors

Short-Term

Period of Finance is required for

Medium-Term Long-Term

Hire Sale of
Leasing Debentures
Purchase Loans Loans Shares

New Issue Rights Issue

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
positionCustomer buys supplies
from manufacturer

Time period to pay for

supplies bought customer
manufacturer
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

M mm
FC ed
i

gi iat
ve e
s $ ly
Co
client 75 customer
py up
of s
M invo l low with
M FC ic C fo nt er e nt
e
ba FC p e to F
M aym tom aym
la a y
nc s p cus s p FC
e e nd to M
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MFC
Medium-Term Finance
Hire Purchase

Own the
Payments Equipment

Return Equipment
Payments 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 Issues • Expensive to Organize &
Advertise

• Raise Additional Capital

Rights Issues • Existing 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 (M- Long-Term
Finance (S-T) 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
 d p i ct u re
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Cho
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 Time Amount
Purpose Status
Period Needed

Choosing the right

Source of Finance

Size Control Risk Gearing

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

Choosing the right

Source of Finance

Gearing is a measure of risk. The

Gearing proportion of total capital raised
from L-T loans.
 d p i ct u re
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shareh
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W ill b a
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 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 shareholder’s 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 force
owners to think ahead
and plan carefully for
first the few years

 Business Objectives
 Important Details
 Operations
 Finances
 Business Plans
Considerations
 Can we break-even or
make a profit?
 Where will the firm be
 What to make? products
located?
 What consumers are we
aiming at?  What machinery will
the firm need?
 What will be the main
costs?  How many staff does
 How many products to the firm need?
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?
MORE
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
Owner’s saving
Governmental grants
Sale of unused asset