Unit 3.2: Sources of Finance

Sources of Finance

Where or how business obtain their funds 

Internal Sources of Finance

Money or funds from within the business

Examples of internal sources of finance

1. Personal Funds: Savings by the entrepreneurs

2. Retained Profit: Profits business keeps after paying taxes and their dividends 

3. The sale of assets: Selling obsolete or dormant assets that they no longer/ or don’t use

Personal Funds

Savings by the entrepreneurs

• Also known as owner’s capital 

• Used for business start-ups 

• Type of fund: short term

Retained Profit

Profits business keeps after paying taxes and their dividends 

• Normally used for capital expenditure 

• Kept in contingency fund for emergencies 

• Benefit: Has no interest charges

• Type of fund: long and short term

The sale of assets

Selling obsolete or dormant assets that they no longer/ or don’t use

• Helps raise finance through selling equipment and old land/building 

• Can seel subsidiaries → When a major liquidity threat is on

• Short term fund

Subsidiaries

a business entity or corporation that is fully owned or partially controlled by another company

Liquidity

the ease with which an asset, or security, can be converted into ready cash without affecting its market price

EG cash is the most liquid asset

External Sources of Finance

1. Share capital

2. Loan/debt capital: 

3. Overdrafts

4. Trade credit

5. Crowdfunding

6. Leasing

7. Microfinance Providers

8. Business Angels

Share capital

The money raised from selling shares in a limited liability company.

• Publicly Held Companies: Comes for their Initial Public Offering (IPO)

• Type of fund: Long term

• Function

  • Enable companies to raise capital

  • Provide a second-hand shares and government market

IPO

• he process in which a private company or corporation can become public by floating their shores on the stock exchange for the first time 

• Can not be done by privately held companies

Share issue/placement

•  an existing publicly held company raises further finance by selling more of its shares.

  • This can dilute the company

Loan/debt capital

medium- to long-term sources of interest-bearing finance obtained from commercial lenders

• Have interest charges placed on them - fixed or variable 

3 main types

1. Mortgages

2. Business Development Loans

3. Debentures

Mortgages

 Loans secured for purchasing property 

• If the borrower defaults on the loan then the lender can repossess the property

  • defaults on the loan: Not pay it back 

  • Reposses: Take it back

Business Development Loans:

Very flexible loans that cater to the specific needs of the borrower to develop certain parts of their business

• Eg, starting, expanding, purchase equipment

Debentures

• They provide finance without having any ownership or rights 

  • Increase their gearing ratio

  • Type of fund: long term

Debenture holders

• Receive interest payments even when the business has made a loss and before shareholders get dividends 

  • Eg, individuals, governments or other businesses

Gearing Ratio

•  Business gets more borrowing as a percentage of its total capital employed 

  • Make them more vulnerable if interest rates increase

Capital employed:

• total amount of capital used for the acquisition of profits by a firm or project

Overdrafts

Allows businesses to spend over the amount they currently have 

• Normally until a set limit that was contracted 

• Type of fund: SHort term

• Most flexible form of borrowing in the short term

  • Disadvantage: Can be asked to be repaid on demand of the lender

• FUnction: Used when a large cash outflow is needed 

  • Eg, stocking for peak seasons

  • Best for companies that work with trade credit products → While waiting for their payments they overdraft

Trade credit

allows a business to postpone payments or to 'buy now and pay later'

• The credit provider does not receive any cash from the buyer until a later date - Helps with current cash flow issues

  • Normally from between 30-60 days later

• Type of fund: Long or short term

• Creditor: Person selling the trade credit

• Debtors: Person buying the trade credit

Crowdfunding

The practice of raising finance for a business venture or project by getting small amounts of money from a large number of people, usually through online platforms.

• Getting donations → no need to pay back

• Type of fund: short or long term

Leasing

1. form of hiring whereby a lessee pays rental income to hire assets from the lessor, the legal owner of the assets

• Lessor: The company that is leasing

  • Legal owner of the assets

• Lessee: The customer who is getting a lease

  • They pay rental income to hire assets from the lessor

  • Can be cheaper to lease assets like equipment → for short term

• Advantage: It doesn’t cost much as it is borrowing for the short term

  • Sale-and-leaseback: Involves selling a particular fixed asset to get funds and the immediately leasing it back for cheaper

  • Type of fund: long term 

• Disadvantage:

  • More expensive in the long term than just hire purchasing the asset

Hire Purchase

• ALlows them to pay their creditors in installments over 12-24 months 

  • Until all payments are done it is legally the creditors

Microfinance Providers

1. type of financial service aimed at entrepreneurs of small businesses, especially females and those on low incomes

• Allows disadvantages members of society to get essential financial services to help diminish the effect of their poverty 

  • Most of the time they don’t have access to banking and insurance

• Advantages:

  • Accessibility

  • Job creation

  • Social wellbeing

• Disadvantages: 

  • Immorality

  • Limited finance

  • Limited eligibility

Business Angels

1.  Extremely wealthy individuals who risk their own money by investing in small to medium sized businesses that have high growth potential. 

• Take proactive roles in setting up and running the business venture → Owner can lose some control to the business angel

  • Organization might eventually have to buy out the stakes owned by the business angel if they want control/ownership 

What Business Angels Considers

1. Return on investments

2. The business plan

   • Business angel needs to see if the business knows their market → does it allow for growth 

3. People

   • Need a good team of people who are willing to make it work 

4. Track record

Short term sources of finance

Available for a period of less than one year, used to pay for the daily or routine operations of the business, such as overdrafts and trade credit.

Long-term sources of finance

Available for periods over 12 months 

• Used for purchasing fixed assets and to finance expansions 

SPACED

Factors considered by business to examine the need for which alternative source of finance:

1. Size and status of a firm: 

2. Purpose of finance

3. Amount required

4. Cost of finance

5. External factors

6. Duration