3.1/3.2 intro + sources of finance

non-current assets

• assets that have useful life of more than one year (non-current, fixed)

• property plant equipment

current assets

• cash

• debtors/stock → assets that a business plans to convert into cash in less than one year

capital expenditure

• purchase of assets that have useful life of more than one year (non-current, fixed)

• property plant equipment

revenue expenditure

• spending on all costs and assets that are not fixed (current)

• rent wages taxes

start-up capital

• finance and resources needed by entrepreneur to set up a business

• used to purchase essential capital equipment and premises

working capital

• finance and resources needed to pay for raw materials, day-to-day running costs and credit offered to customers

• current assets – current liabilities

management buyout

existing managers purchase the business from the owners to have full control

why need finance?

• start up capital

• working capital

• internal growth

• external growth

• management buy out

• external factors → recession or customer’s inability to pay → cash to quickly pay debts (liquidity)

• r&d

internal sources of finance

• raised from business’ own assets or retained profits

• includes

  • personal funds (for sole traders)

  • retained profits

  • sale of assets

  • reducing working capital

• advantages

  • no direct cost

  • does not increase debts/liabilities

  • no risk of losing control since not selling shares

• disadvantages

  • slows down growth if only rely on internal

  • opportunity cost

  • companies that are newly formed, unprofitable, or have few extra assets will not have

external sources of finance

• raised from sources outside the business

• short term:

  • bank overdrafts

  • trade credit

• medium term:

  • hire purchase

  • leasing

• long term:

  • share capital (equity finance)

  • debentures (debt finance)

  • long-term bank loans (debt finance)

  • gov grants

  • venture capital

  • business angels

  • crowdfunding

  • microfinance

personal funds

• internal source of finance

• used for start-up capital, only for sole traders

• advantages

  • no interest since not borrowing money

  • owner has more control

• disadvantages

  • limited to owner’s savings

  • increased risk for owner

retained profit

• internal source of finance

• profit after all reductions (interest, tax, dividends) have been made (found in profit loss statement)

• invested back into the company as an internal source of finance, used for expansion

• advantage: permanent source of finance since not paid out to shareholders

• disadvantage: companies that are newly formed or unprofitable will not have

sale of assets

• internal source of finance

• no longer used → sold for cash

• intend to use but do not need to own → sale and lease back deal: sell to leasing specialist (lessor) and lease back

• leasing advantages

  • able to operate many assets with lower initial costs, able to grow

  • can return assets to the lessor after a fixed period

• leasing disadvantages

  • additional fixed cost of leasing charges

reducing working capital

• internal source of finance

• working capital: finance and resources needed to pay for raw materials, day-to-day running costs and credit offered to customers

• reduce working capital → reduce current assets (debtors and stock)→ capital released can be used as a source of finance

• disadvantage: reduces liquidity, high risk

bank overdrafts

• short term external source of finance

• customer can draw up to an agreed limit from their account as and when required, a form of borrowing

• used for daily expenses since may exceed daily revenue

• advantages

  • flexible: can withdraw different amounts each day

  • can overdraw: borrow more than the account balance → in case need money urgently

• disadvantages

  • high interest

  • bank may call in the overdraft if concerned about liquidity of the business

trade credit

• short term external source of finance

• delay payment to suppliers, aim to pay within 1-2 months

• used for financing inventory increase or sales which will also be paid in credit

• advantage: no interest

• disadvantage: if take too long, lose trust of supplier and miss out on discounts for quick payment

leasing

• medium term external source of finance

• obtain the use of machines/equipment by paying a rental charge over a fixed period → asset belongs to the leasing company

• used for obtaining assets with medium life span (vehicles, equipment, computers)

• advantage: avoids the need for cash payment to buy the asset

• disadvantage: expensive

hire purchase schemes

• medium term external source of finance

• asset is sold to a company which makes fixed repayments over a period of time → asset belongs to the company after final payment has been made

• used for obtaining assets with medium life span (vehicles, equipment, computers)

• advantage: avoids the need for large initial cash payment to buy the asset

• disadvantage: expensive

debt finance/loan capital

• includes long-term bank loans/selling debentures

• increases debts of company temporarily

• advantages

  • no shares sold, no dilution of ownership

  • lenders have no control: no voting rights

  • repaid eventually, so only temporary increase in debt

  • interest charges are paid with profit before tax → lowers tax bill

• disadvantages

  • the interest is paid based on the lender’s terms

  • gearing ratio of company increases → higher risk for shareholders (but also higher reward)

long-term bank loans

• long-term external source of finance used for increasing revenue (so that it can be paid back in time)

• fixed rates have less uncertainty BUT expensive if interest rate high

• disadvantages

  • need collateral: asset that bank can sell if not repaid in time

  • if cannot provide collateral, need agree to higher interest rates

selling debentures

• long-term external source of finance

• used for: expansion, purchasing equipment that lasts many years (fixed/non-current assets)

• company issues bonds to investors to raise debt finance

• company pays a fixed interest rate, up to 25 years

• buyers can resell if not interested in waiting until maturity (getting original investment back)

• convertible debentures: can switch to shares in the company after a period of time → company won’t have to pay back the original investment

• advantages

  • fixed interest

  • usually no collateral

• disadvantages

  • need to repay original investment + interest at end of term

  • need to pay a competitive interest rate

equity finance/share capital

• raised through sale of shares (long-term external source of finance)

• used for expansion, takeovers

• advantages

  • permanent → don’t need repay

  • don’t need to “repay” regularly (via dividends → only when profiting)

  • no interest

• disadvantages

  • shareholders usually expect dividends

  • dividends are paid using profits after interest and tax

ways to sell

• public issue by prospectus (aka stock market floatation/going public)

  • advertises the company and its share sale to the public

  • -) expensive admin costs

  • -) loss of control

• arranging a placing of shares with institutional investors (for private limited)

  • rights issue: existing shareholders entitled to purchase additional shares at a discounted price → raise further capital by selling additional shares

  • +) retain control

  • +) no need to spend money to publicly advertise

  • -) rights issue leads to decreased existing share price → loss of confidence

gov grants

• long-term external source of finance used for small businesses/businesses in enterprise zones

• advantage

  • permanent → doesn’t need to be repaid

• disadvantage

  • terms and conditions

business angels

• external long-term source of finance used for entrepreneurs

• pitch business plan to individual with business experience → directly invests part of their wealth and provides guidance

• advantages

  • will make decision to invest quickly since they are experienced

  • usually concentrates investments on an area in which they have local knowledge

  • can use experience to guide decision-making

• disadvantages

  • usually want share of ownership and profits

venture capitalists

• external long-term source of finance used for high-risk businesses not on the stock exchange → venture capital lends capital or purchases shares

• advantage: willing to invest in business with high-risk high-reward

• disadvantage: will expect share of profits and control

microfinance

• external long-term source of finance used for people with good idea but have no other option lol

• specialist financial businesses lend small loans

• disadvantage: loans must be repaid in full

crowd funding

• external long-term source of finance used for financing a new business venture

• explain business, objective and why finance is needed → raise small amounts of capital from large number of people

• advantages

  • more willing to invest small sums

  • publicity generated also helps promote product

• disadvantages

  • usually expect some form of return: reward-based, equity-based or loan-based

  • high failure rate

  • idea may be copied before business can start

  • difficult to keep track of so many investors