2.1 - Raising finance

How long are short term sources of finance for?

Under one year

What are short term sources of finance?

Bank overdraft Trade credit

How long are medium term sources of finance for?

2-4 years

What are medium term sources of finance?

Bank term loan Leasing

How long are long term sources of finance for?

5+ years

What are long term sources of finance?

Owners' savings Sale of shares Reinvested profits Venture capital loans

What are sources of finance?

The options available to a business when seeking to raise funds to support future business actions

What does a start-up business need finance for?

To buy equipment, raw materials and obtain premises

What does an established business need finance for?

To expand Funding the purchase of additional equipment, raw material and premises

Define internal sources of finance

Money provided by the business or its owners

What are internal sources of finance?

Owner's capital Retained profit Sale of assets

Where will most start up businesses require to get their start up capital from?

Owner's capital

Where does owner's capital come from?

Their own personal resources like personal savings, redundancy payments, inheritance and re-mortgaging their home

What is retained profit?

Profit after tax that is put back into the business and not returned to the owners

Is retained profit available for start up businesses?

No

What is sale of assets?

Where established businesses sell unwanted assets to raise finance

Which assets can be sold?

Property/buildings Machinery Land Obsolete stock Part of a business

What does sale and leaseback of assets involve?

A business selling assets but leasing them back from the person who purchased the assets

When would sale and leaseback of assets happen?

Where cash is needed but the business still needs to use the asset

What does leasing mean?

Renting

Advantages of internal sources of finance

The money is available immediately It is cheap - there are no interest payments so costs are lower and profits higher, very important for new start up businesses/small businesses

Disadvantages of internal sources of finance

The amount of money available may be limited - retained profit levels can be low in new businesses, there may be no suitable assets to sell, owners may have no spare funds Shareholders may resist the use of retained profit to fund business investment, as they want higher dividends

Define external sources of finance

Money that comes from outside a business

What are external sources of finance?

Family and friends Banks Peer to peer lending Business angels Crowdfunding Other businesses

What are methods of finance?

Loans Share capital Venture capital Overdrafts Leasing Trade credit Grants

Describe family and friends

Suitable for start-up or small businesses Could be in the form of a gift or a loan Interest rates likely to be low Problems occur if amount available is too small or difficulties in repaying the amount borrowed as relationships can suffer

Describe banks

Provide loans, overdrafts and mortgages to businesses A formal application must be provided usually with the addition of a business plan for start-up businesses Banks offer advisory services to businesses which can be very helpful for start-ups

Describe peer-to-peer lending

Involves lending money without the use of a bank Transactions take place online through specialists such as Zopa and Funding Circle Loans are unsecured which means there is no protection for lenders therefore they may lose the amount lent if the borrower defaults on the repayments Interest rates tend to be lower than those offered by a bank

Describe business angels

Individuals who typically invest between £10,000-£100,000 in exchange for a stake in the business This source of finance tends to be used by start-ups or small businesses as they expand Business advice is provided The finance may or may not be repaid but it is usual for business angels to want a say in the running of the business as they are a part owner This can lead to problems if the entrepreneur wants to go in a different direction or doesn't want to share profit

Describe crowdfunding

Online platform where individuals invest in a business Funds are donated through a crowdfunding platform such as Kickstarter or Crowdcube A business needing finance posts a video, details of the business and the monetary target needed on the crowdfunding platform Donations from individuals can be given without conditions or in return for gifts or monetary rewards If the target amount isn't raised the business doesn't receive any money from the donations

Describe other businesses

Purchasing shares in another business in order to benefit from dividends or with a view to purchasing enough shares to have a controlling interest in that business Forming a joint venture with another business in order to share the finance, costs and profit from a business venture Common when setting up in a new country

Describe loans

Banks typically provide loans to businesses They may be secured or unsecured A secured loan means the borrower has provided some assets as collateral/security in the event that they default on the repayments of the loan, the lender can sell the assets and use the cash to repay the loan Advantage = the lender has no ownership of the business Disadvantage = loan must be repaid with interest over a set period of time, the interest charged can be fixed or variable

Describe share capital

The money raised from the sale of shares Only available to limited companies and can be used to raise large amounts of money Advantage = share capital is not repaid, therefore there is no interest to pay Disadvantage = shareholders expect dividends (share in the profit) and hold voting rights which entitles them to vote to re-elect the existing board of directors or replace them In a PLC the shareholders can put pressure on the directors to reduce retained profit in order for higher dividends, this creates a short-term focus on maximising profit rather than a long term focus on growing the business

Describe venture capital

Finance raised from venture capitalists Specialist businesses who invest in high risk but potentially very profitable businesses They will take a stake in the business therefore profits and control must be shared They are often used when a business is unable to obtain a loan from a bank

Describe overdrafts

Short term, flexible loan from a bank Business can spend more money than it has in its account Agreed overdraft limit and interest is charged when the overdraft is used Interest rates tend to be much higher on overdrafts than loans therefore an overdraft is a short term method of finance Overdrafts can be called in by the bank at short notice

Describe leasing

A lease is a contract to acquire the use of resources such as property or equipment in return for regular payments The business leasing resources does not own them and is not responsible for the maintenance or repair costs Typically used for vehicles and small equipment Long term use of leasing can be very expensive

Describe trade credit

Used to purchase raw materials and pay for them at a later date, usually within 30-90 days Short term method of finance used by businesses buying from other businesses Discounts can be gained by paying earlier than the specified term

Describe grants

Provided by government for certain types of businesses and circumstances Grants do not have to be repaid but they can be difficult for most businesses to qualify for

Which finance is suitable for unlimited liability businesses?

Retained profit Grants Bank overdraft Mortgage Unsecured bank loans Peer-to-peer lending Crowdfunding Personal savings

Which finance is suitable for limited liability businesses?

Retained profit Grants Bank overdraft Secured and unsecured loans Trade credit Leasing Venture capital Business angels Share capital

Describe unlimited liability

A legal status which means that business owners are liable for all business debts Also known as unincorporated businesses

Describe limited liability

A legal status that means shareholders can only lose the original amount they invested in a business Also known as incorporated businesses

Which types of business ownership have unlimited liability?

Sole trader Partnership

Which types of business ownership have limited liability?

Ltd Plc

Implications of unlimited liability

Have to pay business debts from their own personal resources This may involve selling private assets such as a house or car to pay off debts However it may be easier to raise finance due to the fact that any loan or debt will be the responsibility of the business owner therefore owners tend to be more careful as their personal assets are at risk

Implications of limited liability

The owners of businesses with limited liability are shareholders If a limited company collapses the owners' private assets are fully protected because the legal identity is separate to its owners Able to raise large sums of money from the sale of shares as investors know their private assets are protected and their liability is limited to the size of their investment However in the case of small private limited companies the directors who are also shareholders may have to give personal guarantee to lenders so they will then be liable for those debts in the event that the company cannot pay

What is a business plan?

A document which describes how an entrepreneur plans to set up a new business

What information does a business plan include?

The nature of the business The founder's details and skills Legal ownership The products/services being offered The business objectives A forecast of sales, profit and cash flow

Who needs a business plan?

Entrepreneurs and potential investors

Why do entrepreneurs need a business plan?

It carefully sets out what they are planning to do It helps identify any issues and how they plan to overcome them

Why do potential investors need a business plan?

It outlines the amount of investment needed and what the entrepreneur plans to do with the money

How can you make the business plan work?

Use relevant secondary data that exists - useful and cost effective Carry out some valid primary research to establish demand Use expert advice e.g. banks Talk to others in the industry Look at similar products/businesses and learn from their mistakes

Benefits of a business plan

Forces an entrepreneur to have a logical and detailed breakdown of the business idea Can identify weaknesses or a gap in knowledge or experience Helps secure funding from a bank or other investors Progress can be viewed against the initial plans

Limitations of a business plan

Very difficult to make accurate forecasts Success is not guaranteed Opportunity cost of time spent planning instead of starting to sell May need help from an advisor which can cost money Can restrict creativity if too much is planned

What is cash flow?

The money coming into and going out of the business

Why is cash flow not profit?

Because a profitable business can have a negative cash flow

How can businesses keep cash in?

By delaying paying business they owe (creditors/payables) for as long as possible

How can businesses put more cash into the business?

Collect any outstanding money owed to them (debtors/receivables) as quickly as possible

What does a cash flow forecast support?

Applications for loans

What do cash flow forecasts help businesses do?

Predict periods where they will be short of cash and make arrangements to cover this shortfall

What are some reasons for cash flow problems?

A start-up business may give customers (receivables) time to pay for goods Suppliers (payables) often demand immediate payment New businesses often spend large amounts on marketing, reducing the amount of cash available Start-up businesses do not have access to retained profits

What are inflows?

Money received from customers and other sources like sales of products, capital from the owners, bank loans and grants

What are outflows?

Money paid for suppliers, rent, salaries and advertising

Why is cash flow important?

A business cannot survive without cash A business must make sure that there is always enough cash available

Does a negative closing balance mean a business is bankrupt?

No

How is net cash flow calculated?

Cash inflow - cash outflow

How is closing balance calculated?

Net cash flow + opening balance

How is opening balance calculated?

It is the closing balance from the previous month

Why do businesses prepare cash flow forecasts?

To identify timing of cash shortages and surpluses, so that they can take action such as arrange an overdraft or loan, buy some new equipment To obtain more finance - banks require cash flow information To monitor the flow of cash through the business and identify problem areas and plan for the future

Limitations of a cash flow forecast

Prediction of future cash flow, likely to be inaccurate Difficult for start-up businesses to have accurate estimates as there is no previous data Difficult to estimate future sales due to many factors inside and outside of the business's control Only looks at cash, profit is ignored

How does cash flow affect businesses?

Ideally, businesses want to delay paying businesses they owe (creditors/payables) for as long as possible which keeps cash in the business Businesses also want to collect any outstanding money owed to them (debtors/receivables) as quickly as possible which puts more cash into the business

What is a cash flow forecast?

Prediction of future cash flows

Describe the cash flow forecast

It lists all the future cash inflows and outflows expected over a future period of time It is a prediction of the future, it has not happened yet It is a very important business document