3.2 Sources of Finance

Internal Sources of Finance examples

• Personal Funds

• Retained Profit - Reinvested Earnings

• Sale of Assets

Personal Funds (Owners own money)

An internal source of finance where there is:

• No interest / repayment

• A limited amount of personal risk

Retained Profit

Reinvested earnings

• Cheap, no dilution of control

• Only profitable if, lower dividends

Sale of Assets (Sell unused assets for cash)

An internal source of finance which is:

• Quick Capital, no debt

• Not sustainable; may affect operations

External Sources of Finance

• Share capital

• Loan Capital

• Overdrafts

• Trade Credit

• Leasing

• Crowdfunding

• Microfinance Providers

• Business Angels

• Debentures

Share Capital

Money raised from selling shares - produces a large sum of finance

Loan Capital and +s -s

• Borrowed from banks; repaid interest

• Long-term finance for expansion/assets

+ Big sums, spread costs

- Interest, must pay

Overdrafts and +s -s

• Short term bank borrowing; flexible limit.

+ Quick and pay interest only on use.

- Expensive, can be withdrawn by the bank at anytime

Trade Credit and +s -s

• Buy now, pay later (30-90 days)

+ Aids cash flow.

- Lose discounts, risk supplier issues.

Leasing and +s -s

• Rent assets, don’t own.

+ Spreads cost, maintenance often covered by suppliers.

- Higher long term cost.

Crowdfunding and +s -s

• Online funding from many small investors / donors.

+ Promotes business and raises capital.

- Unreliable, ideas exposed.

Microfinance and +s -s

• Gives small loans to poor entrepreneurs/ small business.

+ Accessibility, microfinance helps those in poverty become independent, whereas commercial banks don’t lend such amounts and to this particular demographic.

+ Job creation, the effective use of microfinance can help to create new job opportunities, with beneficial effects on society as a whole.

- Immorality, critics argue that microfinance is unethical as the providers are for-profit organisations, as they profit from the poor and unemployed.

- Limited eligibility - not all poor individuals qualify for it. As for-profit organisations microfinance providers have to minimise their own risk.

Business angels and +s -s

• Extremely wealthy individuals who choose to invest their own money. They consider ROI - whether it is worthwhile and also the business plan and their track record.

+ Provide capital and experience.

+ Close relationships to the entrepreneur.

- May intefere too much, pressure to perform.

- Owner loses some control to business angels

Debentures and +s -s

• Long term fixed interest loan issued by another business or individual to raise finance for a business, at the end of the loan interest is payed.

+ Interest rate is fixed which can help with budgeting and planning.

- Not flexible as it is a long term loan.

Short term sources of finance

• Available for less than a year.

• Used to pay for the daily routine operations of the business.

• Anything has to be repaid to the creditors within the current fiscal year or the next 12 months.

Examples: Trade Credit, Overdrafts, Crowdfunding, Retained profits and Sale of Assets.

Long term sources of finance

• Available for more than 12 months from the accounting period.

• Used for the purchase of fixed assets or to finance the expansion of a business.

Examples: Debentures, Share capital, leasing, microfinance, business angels and loan capital.

Key factors in Financial Decisions

• Size and status of a firm - larger, established firms, generally have more options and can secure cheaper finance.

• Purpose of finance - the use determines the type of finance needed e.g. buying a factory requires long term finance such as debentures, but covering a short term cash shortfall requires a short term finance e.g. an overdraft.

• Amount required - small amount might be covered by an overdraft or retained profit’s. Large amounts often require share capital or long term loans.