Business - Finance

sources of finance

-retained profits

-sales of assets

-share issue

-bank loan

-commercial mortgage

-debt factoring

-debentures

-grants

-venture capital

-crowd funding

retained profits

a business holds back profits from previous years in order to reinvest into the business

retained profits advantages

-can be used to make larger purchases, such as non-current assets

-no interest needs to be paid on borrowing

-the business doesn't go into debt

retained profits disadvantages

a business can find it more difficult to grow if it regularly uses retained profits

sales of assets

involves selling assets the business no longer needs

sales of assets advantages

-the money does not need to be repaid

-money raised from the sale of an asset can boost cash flow

sales of assets disadvantages

if the finance is required urgently, the business may have to sell the asset for less than it's worth

share issue

Selling shares in the business. PLCs sell on the stock market. Ltds sell shares privately

share issue advantages

-Very large sums of money can be raised

-finance raised does not have to be paid back in the same way as a loan or debenture

share issue disadvantages

-dividends have to be paid to shareholders

-can be expensive to advertise and organise the sales of shares

-PLC's risk losing control of the business to outsiders

bank loan

A bank agrees to lend a business money for a specific purpose, for a fixed period of time. Regular repayment instalments are put in place.

bank loan advantages

-repayments are made in fixed instalments over a set period, making budgetary control easier

-purchases of essential equipment can be made in advance and paid back over a number of years

bank loan disadvantages

-interest has to be repaid along with the loan amount

-small businesses may find it more difficult to secure a loan and often need to pay higher interest rates, as they are considered a greater risk

commercial mortgage

A large sum of money borrowed from a bank or building society secured on a property

commercial mortgage advantages

-can be paid back over a long period of time

-the interest rate charged is often lower than the rate on a bank loan

-fixed interest rates can be arranged so that the organisation knows what it's monthly payments will be for the foreseeable future

commercial mortgage disadvantages

-interest has to be repaid along with the loan amount

-mortgages are secured against a property. Failure to meet monthly repayments can result on the property being repossessed by the bank

-a large deposit on the value of the mortgage is usually required upfront

-when interest rates are not fixed, monthly repayments can vary greatly depending on current interest rates

debt factoring

A business sells its unpaid customer invoices to a factoring company. The factoring company then collects and keeps the customers debts

Debt factoring advantages

-responsibility for collecting the debt is passed on to the factor, saving the business time and effort

-cash flow is improved by receiving an advanced payment of the debts from the factor

debt factoring disadvantages

-the business has to sell the customer debt for a reduced amount

-factoring companies are usually only interest in large amounts of debt

Debentures

public limited companies can borrow money from private individuals through the stock market. These are long term loans. Debenture holders receive interest annually and the firm must repay the loan on a specified repayment date

debentures advantages

-control of the business is retained

-can be paid back over a long period of time

-the company only has to pay interest each year

debentures disadvantages

-if the business fails to make interest payments or repay the debenture at the end of the repayment term, the debenture holder will be able to seize assets from the business

-debenture interest must be paid annually, even if the company makes a loss

grants

a grant is a sum of money given to an organisation which doesn't need to be paid back

grant advantages

-usually given to the business in one lump sum

-the money does not need to be repaid

-they are often offered as an incentive and a way of helping business get started or expand

grant disadvantages

-usually only given once

-might not involve a large amount of cash

-can be complicated to apply for and can require the business to meet certain requirements

venture capital

provide loans to businesses that a bank or other lender consider to be too risk. In return for lending the money the usually acquire a share in the business

venture capital advantages

-large amounts of investment can be gained

-businesses with a risky credit rating can secure finance from a reputable firm

venture capital disadvantages

part-ownership of the business can be requested to secure the finance, meaning the owners equity share is diluted

crowd funding

if a business wants to raise money through crowd funding they can pitch for it by posting details of their project, business or idea on a crowd funding website. People can choose to invest money into the project. Small amounts of money are raised from a large number of people

crowd funding advantages

-incentives may be offered which will encourage more people to invest

-finance can be raised from individual when banks see a venture as too risky

-some funds are donated, so there is nothing to repay

crowd funding disadvantages

-there is a low success rate. Only a small percentage of crowd funded ventures get off the ground, often because they have not reached their target amount

-privacy can be a problem as ideas become public and can therefore be copied

-some crowd funding websites charge investors a fee, which may be a percentage of any profits they make. This may discourage people from investing

factors affecting sources of finance

Short-term finance required = an organisation may only need finance for a short term, perhaps to cover a cash flow problem so an overdraft could be used

Long-term finance required = an organisation may need long term finance, perhaps to fund the purchase of property so would choose a mortgage

Interest rates = an organisation will choose the finance the finance with the lowest interest rate available. Often a hire purchase agreement will have a lower interest rate than a bank loan so would be selected to keep the cost of the finance as low as possible

Payback term = the quicker the payback term, the less interest the organisation will pay on borrowing

Size and type of organisation = organisations are restricted to certain sources of finance, for example a public sector organisation cannot sell shares and has to rely on government funding

purposes of preparing a budget

planning - the business can forecast what will happen. Setting a budget allows any potential surplus or deficit to be identified in advance, the business can then take action to resolve this

co ordinating - budgets ensure that everyone in the organisation is working towards the same aims and objectives

evaluating - actual results can be compared with the budget to evaluate performance at the end of an accounting period

purpose of cash budgeting

-used to forecast the income and expenditure from producing and selling goods over a given period of time

-most businesses do not fail because they aren't profitable but because they have liquidity problems. This means that they do not have enough money coming into the business to pay all the costs and debts that need to be paid

-cash budgets hep the business to plan the flow of cash coming in and going out of the business and so help prevent the business failing

why are cash budgets used

-to predict a cash surplus. The business can then decide how this money will be spent

-to predict a cash deficit. The business can then take action to avoid this

-to allow actual figures to be compared with budgeted figures at the end of an accounting period. This can be used to measure the performance of a business

-to highlight periods where expenses may be high this will allow action to be taken to control spending

-to set targets for individual departments to achieve. This will allow the business as a whole to stay within budget as predicted

-to empower employees as each department can be set a budget which will give department manager's responsibility of spending and recording their finances

information shown on a cash budget

opening balance - the amount of cash the business is expected to have at the start of each month. The opening balance for a particular month is the closing balance from the previous month

receipts - money expected to come in to the business each month

•cash sales - sales which are paid for upfront

•credit sales - sales which are paid for at a later date, as agreed between the business and customer

•sale of old equipment

•receiving a loan/grant

•rent if business sublets part of its premises to a third party